We study a discriminatory limit-order book in which uninformed market makers compete in nonlinear tariffs to serve an informed insider. Our model allows for general nonparametric specifications of preferences and for arbitrary discrete distributions for the insider's private information. We show that adverse selection severely restricts possible equilibrium outcomes: in any pure-strategy equilibrium, tariffs must be linear and at most one type may trade, leading to an extreme form of market breakdown. As a result, such equilibria only exist under exceptional circumstances. The Bertrandlike logic underlying these results markedly differs from Cournot-like analyses of the limit-order book that postulate a continuum of types. We argue that these contrasting outcomes can be reconciled when one considers "-equilibria of either the game with a large number of market makers or the game with a large number of insider types. Mixed-strategy equilibria, by contrast, lead to a new class of equilibrium predictions that calls for further analysis.
Adverse Selection; Competing Mechanisms; Limit-Order Book;
- D43: Oligopoly and Other Forms of Market Imperfection
- D82: Asymmetric and Private Information • Mechanism Design
- D86: Economics of Contract: Theory
Regulation, Liquidity and Solvency Risks