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Which Inter-dealer Market Prevails? An analysis of inter-dealer trading in opaque markets

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Author Info
Victoria Saporta
Abstract

A number of dealership markets share three common features: customer-dealer trades remain undisclosed, inter-dealer trading forms a substantial part of total trading and dealers have a choice, when dealing with each other, between doing so directly and using an inter-dealer broker (IDB). Using a three-stage market microstructure model, we show that for dealers who have executed undisclosed customer trades, their choice depends on the number of firms who operate as dealers: trading through the IDB being preferable when more than a critical number of dealers participate in the industry and vice versa. Comparative static effects of information asymmetry and market transparency on the critical number of dealers are derived. Subject to a monotonicity constraint, a condition is derived determining which form of inter-dealer market will prevail.

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Paper provided by Bank of England in its series Bank of England working papers with number 59.

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  1. Marco Pagano & Ailsa Roell, 1990. "Auction Markets, Dealership Markets and Execution Risk," CEPR Financial Markets Paper 0008, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 53--56 Great Sutton Street, London EC1V 0DG.
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  3. Garbade, Kenneth D, 1978. "The Effect of Interdealer Brokerage on the Transactional Characteristics of Dealer Markets," Journal of Business, University of Chicago Press, vol. 51(3), pages 477-98, July. [Downloadable!] (restricted)
  4. Forster, Margaret M. & George, Thomas J., 1992. "Anonymity in securities markets," Journal of Financial Intermediation, Elsevier, vol. 2(2), pages 168-206, June. [Downloadable!] (restricted)
  5. Easley, David & O'Hara, Maureen, 1992. " Time and the Process of Security Price Adjustment," Journal of Finance, American Finance Association, vol. 47(2), pages 576-605, June.
  6. Lyons, Richard K., 1995. "Tests of microstructural hypotheses in the foreign exchange market," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 321-351. [Downloadable!] (restricted)
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  7. Pagano, Marco & Roell, Ailsa, 1996. " Transparency and Liquidity: A Comparison of Auction and Dealer Markets with Informed Trading," Journal of Finance, American Finance Association, vol. 51(2), pages 579-611, June. [Downloadable!] (restricted)
  8. Madhavan, Ananth, 1995. "Consolidation, Fragmentation, and the Disclosure of Trading Information," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 8(3), pages 579-603. [Downloadable!] (restricted)
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  10. Stoll, Hans R, 1978. "The Pricing of Security Dealer Services: An Empirical Study of NASDAQ Stocks," Journal of Finance, American Finance Association, vol. 33(4), pages 1153-72, September. [Downloadable!] (restricted)
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  11. Mark D. Flood, 1991. "Microstructure theory and the foreign exchange market," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 52-70. [Downloadable!]
  12. Richard B. Olsen & Ulrich A. Müller & Michel M. Dacorogna & Olivier V. Pictet & Rakhal R. Davé & Dominique M. Guillaume, 1997. "From the bird's eye to the microscope: A survey of new stylized facts of the intra-daily foreign exchange markets (*)," Finance and Stochastics, Springer, vol. 1(2), pages 95-129. [Downloadable!] (restricted)
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  15. Lawrence R. Glosten & Paul R. Milgrom, 1983. "Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders," Discussion Papers 570, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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  16. Kyle, Albert S, 1989. "Informed Speculation with Imperfect Competition," Review of Economic Studies, Blackwell Publishing, vol. 56(3), pages 317-55, July. [Downloadable!] (restricted)
  17. Glosten, Lawrence R, 1989. "Insider Trading, Liquidity, and the Role of the Monopolist Specialist," Journal of Business, University of Chicago Press, vol. 62(2), pages 211-35, April. [Downloadable!] (restricted)
  18. Pagano, Marco, 1989. "Trading Volume and Asset Liquidity," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 255-74, May. [Downloadable!] (restricted)
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  19. Madhavan, Ananth, 1992. " Trading Mechanisms in Securities Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 607-41, June. [Downloadable!] (restricted)
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  20. Perraudin,W. & Vitale,P., 1995. "Information Flows in the Foreign Exchange Markets," Cambridge Working Papers in Economics 9412, Faculty of Economics, University of Cambridge.
  21. Easley, David & O'Hara, Maureen, 1987. "Price, trade size, and information in securities markets," Journal of Financial Economics, Elsevier, vol. 19(1), pages 69-90, September. [Downloadable!] (restricted)
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