Optimal Design of a Financial Exchange

We consider the design of a market for a single asset where a finite number of risk averse traders may trade to share risk from asset endowments. We derive the direct mechanisms that maximize a linear combination of expected revenue and allocative efficiency. We find that the first best allocation is Bayesian-Nash implementable with ex-ante budget balance if and only if the expectations of traders' endowments are proportional to their risk capacities. We show that an optimal direct mechanism has an indirect implementation by a double auction with side payments. Thus there may be cause for regulation of side payments and potential to use them as effective policy tools