Is the financial sector too big?

We propose an equilibrium occupational choice model, where agents can choose to work in the real sector (become entrepreneurs) or in the financial sector (become dealers). Agents incur costs to become informed dealers and develop skills in valuing assets up for trade. The financial sector comprises an organized competitive exchange, where uninformed agents trade and an over-the-counter (OTC) market, where informed dealers are ready to offer attractive terms for the most valuable assets entrepreneurs put up for sale. Thanks to their information advantage and valuation skills, dealers are able to provide incentives to entrepreneurs to originate good assets. However, the opaqueness of the OTC market allows dealers to extract informational rents from entrepreneurs. Trade in the OTC market also imposes a negative externality on the organized exchange, where only the less valuable assets end up for trade. We show that in equilibrium the dealers’ informational rents in the OTC market are too large and attact too much talent to the financial industry.