Working Paper: NBER ID: w20620
Authors: Darrell Duffie; Piotr Dworczak; Haoxiang Zhu
Abstract: We characterize the price-transparency role of benchmarks in over-the-counter markets. A benchmark can, under conditions, raise social surplus by increasing the volume of beneficial trade, facilitating more efficient matching between dealers and customers, and reducing search costs. Although the market transparency promoted by benchmarks reduces dealers' profit margins, dealers may nonetheless introduce a benchmark to encourage greater market participation by investors. Low-cost dealers may also introduce a benchmark to increase their market share relative to high-cost dealers. We construct a revelation mechanism that maximizes welfare subject to search frictions, and show conditions under which it coincides with announcing the benchmark.
Keywords: benchmarks; over-the-counter markets; price transparency; market efficiency
JEL Codes: D43; D47; D83; G12; G14; G18; G21; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| introduction of a benchmark (Y20) | increased social surplus (D69) |
| benchmark reduces search costs (G14) | increased social surplus (D69) |
| benchmark improves matching efficiency (C78) | increased social surplus (D69) |
| benchmark enhances transparency (G38) | increased social surplus (D69) |
| publication of the benchmark (L17) | encourages efficient entry by traders (F10) |
| benchmarks improve matching efficiency for low-cost dealers (C78) | allow traders to differentiate between high-cost and low-cost dealers (D40) |
| introduction of a benchmark (Y20) | lower welfare in already efficient markets (D69) |
| dealers introduce benchmarks (G24) | increase market share (L19) |
| increased volume of trade (F10) | compensate for loss in profit margins (L21) |