Working Paper: CEPR ID: DP10237
Authors: Dan Li; Norman Schuerhoff
Abstract: 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.
Keywords: Decentralization; Immediacy; Liquidity; Market Quality; Municipal Bonds; Network Analysis; Over-the-Counter Financial Market; Trading Cost; Transparency
JEL Codes: G12; G14; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| dealer centrality (L14) | trading efficiency (G14) |
| dealer centrality (L14) | execution costs (G19) |
| central dealers (L81) | intermediation chains (L14) |
| central dealers (L81) | execution speed (C69) |
| central dealers (L81) | markup charged to investors (G24) |
| market-wide illiquidity (G10) | central dealers as liquidity providers (E58) |