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Equilibrium bid-ask spreads and the effect of competitive trading delays

Author

Listed:
  • Elisa Luciano
  • Antonella Tolomeo

Abstract

The paper studies the equilibrium bid-ask spread and time-to-trade in a continuous-time, intermediated financial market. Market makers are monopolists, but random switches to a disintermediated market - interpreted as an option to wait and trade without bid-ask spread - occur. In equilibrium, this lowers spreads dramatically and generates higher fees for smaller investors, especially if their risk aversion is close to the market maker's one. Capital constraints on intermediaries easily lead to a second best. We analyze the effects of policy interventions in favour of disintermediation and deterring speculation on the part of market makers. We conclude for a positive effect of the Volcker rule on costs and liquidity.

Suggested Citation

  • Elisa Luciano & Antonella Tolomeo, 2016. "Equilibrium bid-ask spreads and the effect of competitive trading delays," Carlo Alberto Notebooks 467, Collegio Carlo Alberto.
    • Handle: RePEc:cca:wpaper:467
    as

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    References listed on IDEAS

    as
    1. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
    2. Darrell Duffie & Nicolae Gârleanu & Lasse Heje Pedersen, 2007. "Valuation in Over-the-Counter Markets," The Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 1865-1900, November.
    3. Vayanos, Dimitri, 1998. "Transaction Costs and Asset Prices: A Dynamic Equilibrium Model," The Review of Financial Studies, Society for Financial Studies, vol. 11(1), pages 1-58.
    4. George M. Constantinides, 2005. "Capital Market Equilibrium with Transaction Costs," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 7, pages 207-227, World Scientific Publishing Co. Pte. Ltd..
    5. Ho, Thomas & Stoll, Hans R., 1981. "Optimal dealer pricing under transactions and return uncertainty," Journal of Financial Economics, Elsevier, vol. 9(1), pages 47-73, March.
    6. Dumas, Bernard & Luciano, Elisa, 1991. "An Exact Solution to a Dynamic Portfolio Choice Problem under Transactions Costs," Journal of Finance, American Finance Association, vol. 46(2), pages 577-595, June.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    equilibrium with transaction costs; equilibrium with inter mediaries; infrequent trading; trading delays; endogenous bid-ask spread; OTC markets.;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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