2012a. Bilateral trading in networks

I study a dynamic market-model where a set of agents, located in a network that dictates who can trade with whom, engage in bilateral trading for a single object under asymmetric information about the private values. My equilibrium characterization provides new insights into how economic networks shape trading outcomes. Traders who link otherwise disconnected areas of the trading network become intermediaries. They pay the object at their resale values but, if they have a high value, they consume and extract a positive rent. All other traders, except for the initial owner of the object, make zero profit. The object travels along a chain of intermediaries before someone consumes it. Intermediaries who are located later in the trading chain have a lower probability of acquiring the object, but they pay lower prices for it. Compounding, early intermediaries gain a payoff advantage over late ones. Adding links to the network increases downstream competition and it is beneficial to the initial owner. However, it has ambiguous effects on the other traders and may be detrimental to total welfare, when information is asymmetric. More generally, inefficient outcomes are possible if information is not complete and the network is not fully connected. ∗Special thanks go to Andrea Galeotti and Philippe Jehiel who read several earlier drafts and provided suggestions that improved the paper substantially. I also thank Yeon-Koo Che, Rakesh Vohra and Asher Wolinsky for several insightful conversations. Finally, I thank all seminar participants at Northwestern University for their helpful comments before, during and after my presentation