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Financial Expertise As An Arms Race

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Executive Summary

The authors propose a model in which firms involved in trading securities over invest in financial expertise. Intermediaries or traders in the model meet and bargain over a financial asset. Investment in financial expertise improves the ability of the intermediary to value an asset at short notice when responding to an opportunity to supply liquidity. These investments are made before the parties know about their role in the bargaining game, as proposer or responder, buyer or seller. A prisoner's dilemma arises because investments in expertise improve bargaining outcomes given the other party's expertise, even when the information acquired through expertise has no social benefit.

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