Wednesday, August 02, 2006

Liquidity premium = Insurance?

Greg raises the point that some large lead buyers actually get discounts, contrary to my previous post. I still haven't really thought through his statement that the mortgage vertical has plenty of liquidity, but I do have a possible explanation for the volume discounts. One way to paraphrase my initial wordy post is that the premium is a form of insurance: insurance against the cost of rebalancing the relationships to maintain an orderly market. If a large buyer is coming into your exchange, and his accommodation will require the outlay of expense not only to develop his relationship, but that of the suppliers to fill his order, then you need to protect that investment with insurance. If the buyer is large and reputable then the charge will fall away. And if they provide depth to your buy side that actually encourages further supply, then they may get advantageous pricing compared to smaller buyers.

This argument becomes clearer if we make that (false) assumption that exchanges will buy all supply upfront, and then take fulfillment and counterparty risk whilst trying to sell held inventory. For the most part this does not happen, but if we replace the concept of 'lead inventory' with 'relationship inventory' then it all follows through.


Anonymous Vince B said...

Liquidity benefits both buyers and sellers - at the very least, the exchange could pass along the cost of this incentive premium to either the buyer or the seller depending on the supply and demand. Could buyers be paying a premium to fill their order quicker? They seem to be the one affected the most by partial orders, both in the sense of time value of money (depending on the time required to fill the order) and the opportunity cost of an incomplete order (in theory at least) - either way they lose utility. The exchange itself is concerned with attracting as many possible buyers and sellers (by either high liquidity, ease of integration, and/or low costs) and then screening those participants through price discrimination in the form of fees or transaction costs (or some other way to keep low quality buyers and sellers out without risking liquidity). Exchanges make money on the transaction costs and fees for participation, so their motivation is to reduce all of the frictions between buyers and sellers (ala eBay's justification for purchasing skype). I think it is fair to assume that they are price neutral - so actual prices reflect willingness to pay (assuming there are multiple exchanges connecting buyers and sellers).

Futures contracts on leads sounds very interesting. How do you predict scarcity, grade quality, or hedge against a digital commodity? Good luck bud. This stuff sure beats the stuff I'm working on.

6:55 PM  

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