The Optimal Design of a Market

We study the optimal design of the rules of trade in a two-period market given that agents arrive at different times and may only trade with agents present contemporaneously. First period agents face a fixed cost of trading across periods. Given the non-convexities associated with the fixed cost, competitive trading rules can result in inefficiencies in such a market and anonymity must be sacrificed to achieve efficiency. Efficient trading rules have a market maker (who is given a monopoly right to trade across periods) who faces some competition within period trading, but not across periods. The efficient choice of who should be market maker can be made by auctioning rights to this position. With uncertainty across periods, efficient mechanisms may involve multiple market makers, and the optimal number of market makers depends on the cost of trading, level of risk aversion, and presence of asymmetric information. Journal of Economic Literature Classification Numbers: D40, D78, G10