Moral Hazard and Imperfect Competition in Financial Markets

About this event

Moral hazard is traditionally analyzed as a bilateral principal--agent problem. In financial markets, however, intermediaries (agents) investing on behalf of clients (principals) must compete with one another when trading, creating an interaction between incentives and market clearing. I develop a model to study how frictions arising from moral hazard and imperfect competition interact, and show that greater competition can reduce market efficiency by tightening intermediaries' incentive constraints. Using proprietary data from Canadian equity exchanges, I illustrate the empirical relevance of these frictions and their interaction, highlighting the need to coordinate competition policy and conduct regulation.