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 di erent times and may only trade with agents present contemporaneously. First period agents face a xed cost of trading across periods, and their decisions of whether or not to trade in the second period result in externalities relative to the agents arriving in the second period. Given the nonconvexities associated with the xed cost, competitive trading rules can result in ine ciencies in such a market and, in fact, anonymity must be sacri ced to achieve e ciency. E cient trading rules have a market maker (i.e., an agent who is given some market power and the right to trade across periods) who faces some competition within period trading, but not across periods. The e cient choice of who should be market maker can be made by auctioning rights to this position. If there is uncertainty across periods, then e cient 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. Brusco is at Departmento de Econom a de la Empresa, Universidad Carlos III de Madrid, and Jackson is at MEDS, Kellogg Graduate School of Management, Northwestern University. Financial support under NSF grant SBR 9507912 is gratefully acknowledged. The paper has bene tted from the comments and discussion in several seminars whose participants we thank.