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Essays on Network Games with Incomplete Information, with Applications in Finance

Abstract

This dissertations includes three (3) chapters, each adding to the growing network games literature that incorporates incomplete information. Financial over-the-counter markets give motivating applications. (1) "Trading Networks and Equilibrium Intermediation" studies the efficiency of trade in networks. A network of intermediaries facilitates exchange between buyers and a seller. Intermediary traders face a private trading cost, a network characterizes the set of feasible transactions, and an auction mechanism sets prices. Stable networks, which are robust to agents' collusive actions, exist when cost uncertainty is acute and multiple, independent trading relationships are valuable. A free-entry process governs the formation of equilibrium networks. Such networks feature too few intermediaries relative to the optimal market organization and they exhibit an asymmetric structure amplifying the shocks experienced by key intermediaries. (2) "Interdealer Trade: Risk, Liquidity, and the role of Market Inventory" further studies traders facing private shocks, placed in a dynamic setting. Trades between ex ante symmetric, inventory carrying intermediaries ("dealers") are motivated by divergent liquidity needs of the counter parties. Market prices and asset flows are pinned by dealers' indifference between providing intermediation services and retaining liquidity to be utilized in subsequent interdealer markets. More active interdealer markets simultaneously increase the value to intermediation and the option-value to providing these services. Under infrequent shocks, interdealer trade boosts the availability of liquidity in the broader market. This boost decays with market inventory, which serves as a constraint on interdealer activity. Through this market mechanism, prices vary inversely with both search frictions between dealers and on their total current holdings. (3) "Information Acquisition and Response in Peer-effects Networks" endogenizes the quality of information that market participants carry in a general peer effects model. When pairwise peer effects are symmetric, asymmetries in acquired information are inefficiently low relative to the utilitarian benchmark. And with information privately acquired, all players face strictly positive gains to overstating their informativeness as to strategically influence the beliefs and behaviors of neighbors. If strategic substitutes in actions are present and significant, low centrality players move against their signals in anticipation of their neighbors' actions. A blueprint for optimal policy design is developed. Applications to market efficiency in financial crises and two-sided markets are discussed.

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