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Liquidity in competitive dealer markets

Author

Listed:
  • Peter Bank
  • Ibrahim Ekren
  • Johannes Muhle‐Karbe

Abstract

We study a continuous‐time version of the intermediation model of Grossman and Miller. To wit, we solve for the competitive equilibrium prices at which liquidity takers' demands are absorbed by dealers with quadratic inventory costs, who can in turn gradually transfer these positions to an exogenous open market with finite liquidity. This endogenously leads to transient price impact in the dealer market. Smooth, diffusive, and discrete trades all incur finite but nontrivial liquidity costs, and can arise naturally from the liquidity takers' optimization.

Suggested Citation

  • Peter Bank & Ibrahim Ekren & Johannes Muhle‐Karbe, 2021. "Liquidity in competitive dealer markets," Mathematical Finance, Wiley Blackwell, vol. 31(3), pages 827-856, July.
    • Handle: RePEc:bla:mathfi:v:31:y:2021:i:3:p:827-856
    DOI: 10.1111/mafi.12305
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    References listed on IDEAS

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