Over-the-Counter Markets

We study how intermediation and asset prices in over-the-counter markets are affected by illiquidity associated with search and bargaining. We compute explicitly the prices at which investors trade with each other as well as marketmakers' bid and ask prices in a dynamic model with strategic agents. Bid-ask spreads are lower if investors can more easily find other investors, or have easier access to multiple marketmakers. With a monopolistic marketmaker, bid-ask spreads are higher if investors have easier access to the marketmaker. We characterize endogenous search and welfare, and discuss empirical implications.

[1]  Paul R. Milgrom,et al.  Bid, ask and transaction prices in a specialist market with heterogeneously informed traders , 1985 .

[2]  Randall Wright,et al.  Search, Bargaining, Money, and Prices , 1995, Journal of Political Economy.

[3]  Abdullah Yavas.  Search and Trading in Intermediated Markets , 1996 .

[4]  Sudipto Bhattacharya and Kathleen Hagerty..  Dealerships, Trading Externalities, and General Equilibrium , 1984 .

[5]  Dimitri Vayanos,et al.  Transaction Costs and Asset Prices: A Dynamic Equilibrium model , 1998 .

[6]  Douglas Gale,et al.  Bargaining and Competition Part II: Existence , 1986 .

[7]  Darrell Duffie,et al.  Valuation in Over-the-Counter Markets , 2003 .

[8]  Helmut Bester,et al.  Noncooperative Bargaining and Spatial Competition , 1989 .

[9]  Yeneng Sun,et al.  The exact law of large numbers via Fubini extension and characterization of insurable risks , 2006, J. Econ. Theory.

[10]  Qinglei Dai,et al.  How do Buyers and Sellers Divide the Surplus? Evidence from Tax Arbitrage , 2003 .

[11]  A. Krishnamurthy.  The Bond/Old-Bond Spread , 2001 .

[12]  A. Rubinstein,et al.  Equilibrium in a market with sequential bargaining , 1985 .

[13]  N. Kiyotaki,et al.  A Search-Theoretic Approach to Monetary Economics , 1993 .

[14]  Douglas Gale,et al.  Limit theorems for markets with sequential bargaining , 1987 .

[15]  P. Schultz,et al.  Corporate Bond Trading Costs: A Peek Behind the Curtain , 2001 .

[16]  H. Stoll,et al.  Dealer versus auction markets: A paired comparison of execution costs on NASDAQ and the NYSE , 1996 .

[17]  Marco Pagano,et al.  Trading Volume and Asset Liquidity , 1989 .

[18]  Thomas Gehrig,et al.  Intermediation in Search Markets , 1993 .

[19]  Douglas Gale,et al.  Bargaining and Competition Part I: Characterization , 1986 .

[20]  Burton Hollifield,et al.  Financial Intermediation and the Costs of Trading in an Opaque Market , 2005 .

[21]  Dale T. Mortensen,et al.  Property Rights and Efficiency in Mating, Racing, and Related Games , 1982 .

[22]  M. Harris.  Expectations and Money in a Dynamic Exchange Model , 1979 .

[23]  P. Protter.  Stochastic integration and differential equations , 1990 .

[24]  Arthur J. Hosios,et al.  On The Efficiency of Matching and Related Models of Search and Unemployment , 1990 .

[25]  Jeffrey H. Harris,et al.  Effects of Market Reform on the Trading Costs and Depths of Nasdaq Stocks , 1999 .

[26]  N. G. Parke,et al.  Ordinary Differential Equations. , 1958 .

[27]  Lawrence Harris,et al.  Municipal Bond Liquidity , 2004 .

[28]  Helmut Bester,et al.  Bargaining, Search Costs and Equilibrium Price Distributions , 1988 .

[29]  Espen R. Moen.  Competitive Search Equilibrium , 1997, Journal of Political Economy.

[30]  Y. Amihud,et al.  Dealership market: Market-making with inventory , 1980 .

[31]  W. Bagehot.  The Only Game in Town , 1971 .

[32]  M. Sewell.  Market Microstructure , 2007 .

[33]  Ken Binmore,et al.  Matching and Bargaining in Dynamic Markets , 1988 .

[34]  G. Constantinides.  Capital Market Equilibrium with Transaction Costs , 1986, Journal of Political Economy.

[35]  J. Nash.  THE BARGAINING PROBLEM , 1950, Classics in Game Theory.

[36]  P. DeMarzo,et al.  The Enforcement Policy of a Self-Regulatory Organization , 2000 .

[37]  A. Krishnamurthy,et al.  The Bond/Old-Bond Spread , 2001 .

[38]  Charles R. Schnitzlein,et al.  When It's Not The Only Game in Town: The Effect of Bilateral Search on the Quality of a Dealer Market , 1997 .

[39]  T. Ho,et al.  Optimal dealer pricing under transactions and return uncertainty , 1981 .

[40]  Y. Amihud,et al.  Asset pricing and the bid-ask spread , 1986 .

[41]  Peter A. Diamond,et al.  Aggregate Demand Management in Search Equilibrium , 1982, Journal of Political Economy.

[42]  Gady Jacoby,et al.  On Asset Pricing and the Bid-Ask Spread , 2001 .

[43]  A. Kyle.  Continuous Auctions and Insider Trading , 1985 .

[44]  Donna S. Watson,et al.  The only game in town , 2002 .

[45]  Andrew McLennan,et al.  SEQUENTIAL BARGAINING AS A NONCOOPERATIVE FOUNDATION FOR WALRASIAN EQUILIBRIUM , 1991 .

[46]  C. Pires.  Three essays in economic theory , 1994 .

[47]  David M. Kreps,et al.  A Course in Microeconomic Theory , 2020 .