Activity

Common findings regarding information frictions in over-the-counter (OTC) markets:
* Reduced Asset Creation, Trading Volume, and Welfare: Information asymmetries, where some parties have more or better information than others, fundamentally hinder efficient market operation. In OTC markets, the lack of transparency about counterparty valuations or asset quality can indeed lead to fewer assets being created (as the risk of adverse selection for originators is higher), lower trading volume (as potential mutually beneficial trades are not realized), and ultimately, lower overall welfare compared to idealized complete information economies.
* Loss of Potentially Efficient Trades: This is a core consequence of information friction. If an investor doesn’t know a counterparty’s true private valuation, they might be unwilling to offer a price that would be acceptable to both, or they might fear being exploited. This uncertainty leads to a “bid-ask spread” that is too wide, or simply a failure to find common ground, causing potentially efficient trades (where both parties would benefit) to be forgone.
* Private Information Skews Ownership and Trading Patterns, Favoring High-Valuation Investors: Investors who possess superior private information about an asset’s true value are at an advantage. They can identify undervalued assets and acquire them, or identify overvalued assets and sell them. This naturally skews ownership towards those with better information or higher valuations for specific assets, as they are more likely to successfully bid for or hold onto assets they value highly.
* Reducing the Role of Middlemen: This is an interesting and often observed outcome. In complete information or highly transparent markets, middlemen (brokers, dealers) play a crucial role in matching buyers and sellers, providing liquidity, and facilitating transactions. However, in markets with severe information frictions, the value of a middleman who doesn’t possess superior information themselves is diminished. If the primary problem is that principals can’t gauge each other’s valuations, a middleman who merely connects them without resolving the information asymmetry might not add enough value to justify their fees. Furthermore, high-valuation investors who have private information may prefer to deal directly to avoid revealing their informational advantage to an intermediary, or to avoid paying a spread that incorporates the middleman’s risk premium due to information asymmetry.
In essence, information frictions introduce a wedge between potential gains from trade and actual realized trades, leading to suboptimal outcomes across various dimensions of market activity.

Video courtesy of IPO-VID In Patrick’s Opinion

Video courtesy of IPO-VID In Patrick’s Opinion