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Asset Issuance in Over-the-Counter Markets

Author

Listed:
  • Zachary Bethune

    (University of Virginia)

  • Bruno Sultanum

    (Federal Reserve Bank of Richmond)

  • Nicholas Trachter

    (Federal Reserve Bank of Richmond)

Abstract

We model asset issuance in over-the-counter markets. Investors buy newly issued assets in a primary market and trade existing assets in a secondary market, where trade in both markets is over-the-counter (OTC). We show that the level of asset issuance and its efficiency depend on how investors split the surplus in secondary market trade. If buyers get most of the surplus, then sellers do not have incentives to participate in the primary market in order to intermediate assets and the economy has a low level of assets. On the other hand, if sellers get most of the surplus, buyers have strong incentives to participate in the primary market and the economy has a high level of assets. The decentralized equilibrium is inefficient for any splitting rule. The result follows from a double-sided hold-up problem in which it is impossible for all investors to take into account the full social value of an asset when trading. We propose a tax/subsidy scheme and show how it restores efficiency. We also extend the model in several dimensions and study the robustness of the inefficiency result. Finally, we explore the effects of the inefficiency using numerical examples. We study how bargaining power and trading speed in the secondary market affect the efficiency result, and we notice some interesting implications for policy interventions aimed to restore efficiency to OTC markets. (Copyright: Elsevier)

Suggested Citation

  • Zachary Bethune & Bruno Sultanum & Nicholas Trachter, 2019. "Asset Issuance in Over-the-Counter Markets," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 4-29, July.
  • Handle: RePEc:red:issued:18-175
    DOI: 10.1016/j.red.2019.04.003
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    References listed on IDEAS

    as
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    Cited by:

    1. repec:red:issued:19-0 is not listed on IDEAS
    2. repec:fip:fedreq:00061 is not listed on IDEAS
    3. Kozlowski, Julian, 2017. "Long-Term Finance and Investment with Frictional Asset Markets," Working Papers 2018-12, Federal Reserve Bank of St. Louis, revised 17 May 2019.

    More about this item

    Keywords

    Decentralized markets; Bilateral trade; Asset issuance; Liquidity; Hold-up;

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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