Working Paper: CEPR ID: DP13126
Authors: Julien Hugonnier; Pierre-Olivier Weill; Benjamin Lester
Abstract: We extend Duffie, Garleanu, and Pedersen's (2005) search-theoretic model of over-the-counter asset markets, allowing for a decentralized inter-dealer market with arbitrary heterogeneity in dealers' valuations or inventory costs. We develop a solution technique that makes the model fully tractable and allows us to derive, in closed form, theoretical formulas for key statistics analyzed in empirical studies of the intermediation process in OTC market. A calibration to the market for municipal securities reveals that the model can generate trading patterns and prices that are quantitatively consistent with the data. We use the calibrated model to compare the gains from trade that are realized in this frictional market with those from a hypothetical, frictionless environment, and to distinguish between the quantitative implications of various types of heterogeneity across dealers.
Keywords: over-the-counter markets; search frictions; bargaining; heterogeneous agents; intermediation
JEL Codes: G11; G12; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| dealer heterogeneity (L14) | market outcomes (P42) |
| trading patterns (F10) | bid-ask spreads (G19) |
| trading patterns (F10) | trading volumes (G15) |
| longer intermediation chains (F65) | lower bids (D44) |
| longer intermediation chains (F65) | higher asks (D44) |
| dealer characteristics (L81) | trading dynamics (F12) |
| average inventory duration (C41) | time to sell to customers (L81) |