Non-Exclusive Contracts, Collateralized Trade, and a Theory of an Exchange

Liquid markets where agents have limited capacity to sign exclusive contracts, as well as imperfect knowledge of previous transactions by others, raise the following risk: An agent can promise the same asset to multiple counterparties and subsequently default. I show that in such markets an exchange can arise as a very simple type of intermediary that improves welfare. In particular, the only role of the exchange here is to set limits on the number of contracts that agents can report to it. Furthermore, reporting can be voluntary, i.e., pairs of agents can enter contracts without reporting them to the exchange and the exchange cannot observe whether agents enter such contracts. Interestingly, to implement an equilibrium in which agents report all their trades (voluntarily), the exchange may need to set position limits that are non-binding in equilibrium. In addition, the exchange must not make reported trades public (i.e., it is not a bulletin board). An alternative to an exchange is collateralized trade, but this alternative is costly because of the opportunity cost of collateral. I also show that the gains from an exchange increase when markets are more liquid (in the sense that the fixed costs per trade are lower) or when agents have more intangible capital (i.e., reputation)