Enforcement Problems and Secondary Markets

There is a large and growing literature that studies the effects of weak enforcement institutions on economic performance. This literature has focused almost exclusively on primary markets, in which assets are issued and traded to improve the allocation of investment and consumption. The general conclusion is that weak enforcement institutions impair the workings of these markets, giving rise to various inefficiencies. But weak enforcement institutions also create incentives to develop secondary markets, in which the assets issued in primary markets are retraded. This article shows that trading in secondary markets counteracts the effects of weak enforcement institutions and, in the absence of further frictions, restores efficiency. (JEL: F34, F36, G15) (c) 2008 by the European Economic Association.