Dealer Networks

Dealers in over-the-counter securities form networks to mitigate search frictions. The audit trail for municipal bonds shows the dealer network has a core-periphery structure. Central dealers are more efficient at matching buyers and sellers than peripheral dealers, which shortens intermediation chains and speeds up trading. Investors face a tradeoff between execution speed and cost. Central dealers provide immediacy by pre-arranging fewer trades and holding larger inventory. However, trading costs increase strongly with dealer centrality. Investors with strong liquidity need trade with central dealers and at times of market-wide illiquidity. Central dealers thus serve as liquidity providers of last resort.

[1]  The Market for New Issues of Municipal Bonds: The Roles of Transparency and Limited Access to Retail Investors , 2012 .

[2]  R. Green,et al.  Financial Valuation and Risk Management Working Paper No . 473 Price Discovery in Illiquid Markets : Do Financial Asset Prices Rise Faster Than They Fall ? , 2008 .

[3]  Duane J. Seppi,et al.  Common Factors in Prices, Order Flows and Liquidity , 1998 .

[4]  Péter Kondor,et al.  Trading and Information Diffusion in Over-the-Counter Markets , 2012 .

[5]  Christian Upper,et al.  Estimating Bilateral Exposures in the German Interbank Market: Is There a Danger of Contagion? , 2002, SSRN Electronic Journal.

[6]  Terrence Hendershott,et al.  Click or Call? Auction Versus Search in the Over-the-Counter Market , 2012 .

[7]  Ben R. Craig,et al.  Interbank Tiering and Money Center Banks , 2010 .

[8]  Haoxiang Zhu,et al.  Finding a Good Price in Opaque Over-the-Counter Markets , 2011 .

[9]  H. Demsetz,et al.  The Cost of Transacting , 1968 .

[10]  Bruno Biais,et al.  Price Formation and Equilibrium Liquidity in Fragmented and Centralized Markets , 1993 .

[11]  Charles M. Jones,et al.  Time Variation in Liquidity: The Role of Market Maker Inventories and Revenues , 2008 .

[12]  W. Newey,et al.  A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelationconsistent Covariance Matrix , 1986 .

[13]  Hans R. Stoll,et al.  The Components of the Bid-Ask Spread: A General Approach, Reviews of Financial Studies , 1997 .

[14]  Ricardo Lagos,et al.  Crises and Liquidity in Over-the-Counter Markets , 2009, J. Econ. Theory.

[15]  Hendrik Bessembinder,et al.  Market Transparency, Liquidity Externalities, and Institutional Trading Costs in Corporate Bonds , 2005 .

[16]  Christian Julliard,et al.  Network Risk and Key Players: A Structural Analysis of Interbank Liquidity , 2020, Journal of Financial Economics.

[17]  H. Hotelling.  Stability in Competition , 1929 .

[18]  Yaron Leitner.  Federal Reserve Bank of Philadelphia , 2004 .

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

[20]  Shane A. Johnson,et al.  The Impact of Specialist Firm Acquisitions on Market Quality , 2000 .

[21]  S. Rosen,et al.  Monopoly and product quality , 1978 .

[22]  E. Hotchkiss,et al.  The Informational Efficiency of the Corporate Bond Market: An Intraday Analysis , 1999 .

[23]  G. Rocheteau,et al.  Competing for Order Flow in OTC Markets , 2014 .

[24]  M. Jackson.  A Survey of Models of Network Formation: Stability and Efficiency , 2003 .

[25]  Michael S. Piwowar,et al.  Secondary Trading Costs in the Municipal Bond Market , 2006 .

[26]  Boyan Jovanovic,et al.  Middlemen in Limit Order Markets , 2016 .

[27]  A. Barabasi,et al.  Hierarchical Organization of Modularity in Metabolic Networks , 2002, Science.

[28]  Michael S. Piwowar,et al.  Corporate Bond Market Transaction Costs and Transparency , 2007 .

[29]  Peter Feldhütter.  The Same Bond at Different Prices: Identifying Search Frictions and Selling Pressures , 2010 .

[30]  P. Erdos,et al.  On the evolution of random graphs , 1984 .

[31]  Albert,et al.  Emergence of scaling in random networks , 1999, Science.

[32]  Richard Roll,et al.  Commonality in Liquidity , 1999 .

[33]  Joel Hasbrouck,et al.  Assessing the Quality of a Security Market: A New Approach to Transaction-Cost Measurement , 1993 .

[34]  Bhagwan Chowdhry,et al.  Multimarket Trading and Market Liquidity , 1991 .

[35]  Massimo Marchiori,et al.  Error and attacktolerance of complex network s , 2004 .

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

[37]  Mahdi Jalili,et al.  Error and attack tolerance of small-worldness in complex networks , 2011, J. Informetrics.

[38]  A. Kovner,et al.  Trading Partners in the Interbank Lending Market , 2013 .

[39]  João F. Cocco,et al.  Lending Relationships in the Interbank Market , 2003 .

[40]  Todd T. Milbourn,et al.  CEO reputation and stock-based compensation , 2003 .

[41]  Lawrence Harris,et al.  Corporate Bond Market Transparency and Transaction Costs , 2004 .

[42]  Morten L. Bech,et al.  The Topology of the Federal Funds Market , 2008, SSRN Electronic Journal.

[43]  Burton Hollifield,et al.  "Bid-Ask Spreads and the Pricing of Securitizations: 144a vs. Registered Securitizations" , 2011 .

[44]  Ethan Cohen-Cole,et al.  How Your Counterparty Matters: Using Transaction Networks to Explain Returns in CCP Marketplaces , 2011 .

[45]  Jay F. Coughenour,et al.  Common market makers and commonality in liquidity , 2004 .