NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Legal Protection in Retail Financial Markets

Bruce I. Carlin, Simon Gervais

NBER Working Paper No. 14972
Issued in May 2009
NBER Program(s):   CF

Given the importance of sound advice in retail financial markets and the fact that financial institutions outsource their advice services, what legal rules maximize social welfare in the market? We address this question by posing a theoretical model of retail markets in which a firm and a broker face a bilateral hidden action problem when they service clients in the market. All participants in the market are rational, and prices are set based on consistent beliefs about equilibrium actions of the firm and the broker. We characterize the optimal law within our modeling context, and derive how the legal system splits the blame between parties to the transaction. We also analyze how complexity in assessing clients and conflicts of interest affect the law. Since these markets are large, the implications of the analysis have great welfare import.

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Document Object Identifier (DOI): 10.3386/w14972

Published: Legal Protection in Retail Financial Markets (with Simon Gervais). Review of Corporate Finance Studies 1: 68-108, 2012.

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