Competitive equilibrium is always efficient according to the first welfare theorem because it is assumed that the market structure allows all market participants to trade directly. However, this assumption is relevant only for a small number of financial markets, such as NASDAQ and NYSE, and does not hold for over-the-counter markets that trade trillions dollars of derivatives, bonds, federal funds, FX, commodities, diamonds, and more. These markets involve a lot of intermediation as not all market participants can trade directly with each other because of the credit risk, trust, informational constrains, geographical distance, time zone differences, language differences, etc. This project applies a novel network-based approach to analyze financial markets with intermediation in order to contribute to the debate about the desired structure of the financial system and improve the understanding of the force behind the formation of markets.
A Network-Based Analysis of Financial Markets