Forthcoming in The Journal of Banking and Finance

Two financial services firms (FSFs) produce information on future returns from risky assets, incorporate this information in a report and sell the reports to investors. The FSFs make strategic choices of the quality, differentiation and prices of their reports. Their optimal strategic choices of quality and differentiation divide the market for the report into three segments. Each FSF has a monopoly in its own segment, and the two compete head-to-head in a duopoly segment. The sizes of the monopoly segments increase with increases in quality and differentiation. An increase in differentiation reduces the size of the duopoly market, while an increase in quality has an ambiguous effect on the duopoly market: for high enough equilibrium differentiation, the size of the duopoly market decreases with an increase in quality. The non-cooperative FSFs pursue niche strategies, each focusing on a different related set of risks, in order to coordinate the contents of their reports to achieve the equilibrium degree of product differentiation. Recent years have seen a worldwide wave of financial-firm mergers and acquisitions. This paper’s model suggests that in equilibrium FSFs differentiate their products and develop profitable niches; in principle, however, sufficiently strong economies of scope could lead a small number of FSFs with little differentiation that dominate all financial services markets. JEL classifications: G20, D83, D43