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Exclusive Portfolio Dealing and Market Inefficiency

Working paper 802
Working Papers
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Published: 10 February 2024

By: Natalie Kessler Iman van Lelyveld Ellen van der Woerd

We rationalize exclusive portfolio dealing in a novel three-period partial equilibrium framework populated by a representative, risk-neutral seller and a small number of ex ante identical broker-dealers. Endowed with independent, uncertain demand for a representative asset, the broker-dealers may compete in prices for exclusivity. If no exclusivity is granted, due to either the lack or seller rejection of offers, the seller enters a second-price auction with a zero-loss reserve price. While seller profits are constant under exclusivity (Bertrand Paradox), auction profits increase in the number of broker-dealers. Therefore, exclusivity arises in equilibrium only for a seller with at most two broker-dealers, reducing the trade frequency by one-third. The results are robust to endogenizing the number of broker-dealers and to allowing for the ex post asymmetry in asset demand. Exclusivity, however, does not arise when the auction features a seller-optimal reserve price. We motivate and conclude with an application to the security lending market.

Keywords: Exclusive Dealing; Intermediated Markets; Competition; Market Efficiency
JEL codes G14; G24; D43; D86

Working paper no. 802

802 - Exclusive Portfolio Dealing and Market Inefficiency

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Research Highlights

  • We model trading between a representative seller and competing broker-dealers to study the phenomenon of exclusive dealing in intermediated markets.
  • We show that seller profits are constant under exclusivity (Bertrand Paradox), while non-exclusive profits increase in the number of broker-dealer connections. Therefore, exclusive dealing is granted by sellers with initial access to at most two broker-dealers.
  • We show that exclusive dealing is anti-competitive in nature and reduces trading volume by up to one third at the seller level.
  • In the EU-based equity lending market exclusivity-induced inefficiencies aggregate to up to 42.30 bn euro annually in foregone trading.

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