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Competing for Order Flow in OTC Markets

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  • BENJAMIN LESTER
  • GUILLAUME ROCHETEAU
  • PIERRE‐OLIVIER WEILL

Abstract

We develop a model of a two‐sided asset market in which trades are intermediated by dealers and are bilateral. Dealers compete to attract order flow by posting the terms at which they execute trades—which can include prices, quantities, and execution speed—and investors direct their orders toward dealers who offer the most attractive terms. We characterize the equilibrium in a general setting, and we illustrate theoretically and numerically how the model can account for several important trading patterns in over‐the‐counter markets, which do not emerge from existing models.

Suggested Citation

  • Benjamin Lester & Guillaume Rocheteau & Pierre‐Olivier Weill, 2015. "Competing for Order Flow in OTC Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(S2), pages 77-126, June.
  • Handle: RePEc:wly:jmoncb:v:47:y:2015:i:s2:p:77-126
    DOI: 10.1111/jmcb.12215
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    Cited by:

    1. Hendershott, Terrence & Li, Dan & Livdan, Dmitry & Sch�rhoff, Norman, 2017. "Relationship Trading in OTC Markets," CEPR Discussion Papers 12472, C.E.P.R. Discussion Papers.
    2. Jean-Edouard Colliard & Thierry Foucault & Peter Hoffmann, 2018. "Inventory Management, Dealers' Connections, and Prices in OTC Markets," Working Papers hal-01933855, HAL.
    3. Ghent, Andra C., 2021. "What’s wrong with Pittsburgh? Delegated investors and liquidity concentration," Journal of Financial Economics, Elsevier, vol. 139(2), pages 337-358.
    4. Julien Hugonnier & Benjamin Lester & Pierre-Olivier Weill, 2020. "Frictional Intermediation in Over-the-Counter Markets," Review of Economic Studies, Oxford University Press, vol. 87(3), pages 1432-1469.
    5. Shen, Ji & Wei, Bin & Yan, Hongjun, 2016. "Financial Intermediation Chains in an OTC Market," MPRA Paper 74925, University Library of Munich, Germany.
    6. Chang, Briana & Zhang, Shengxing, 2015. "Endogenous market making and network formation," LSE Research Online Documents on Economics 86275, London School of Economics and Political Science, LSE Library.
    7. Semih Üslü, 2019. "Pricing and Liquidity in Decentralized Asset Markets," Econometrica, Econometric Society, vol. 87(6), pages 2079-2140, November.
    8. Roc Armenter & Benjamin Lester, 2017. "Excess Reserves and Monetary Policy Implementation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 23, pages 212-235, January.
    9. Dan Li & Norman Schürhoff, 2019. "Dealer Networks," Journal of Finance, American Finance Association, vol. 74(1), pages 91-144, February.
    10. Zhang, Shengxing, 2018. "Liquidity misallocation in an over-the-counter market," Journal of Economic Theory, Elsevier, vol. 174(C), pages 16-56.
    11. Chang, Briana & Zhang, Shengxing, 2015. "Endogenous market making and network formation," LSE Research Online Documents on Economics 65105, London School of Economics and Political Science, LSE Library.
    12. Kurmann, André & Rabinovich, Stanislav, 2018. "Dynamic inefficiency in decentralized capital markets," Journal of Economic Theory, Elsevier, vol. 173(C), pages 231-256.
    13. Miroslav Gabrovski & Ioannis Kospentaris, 2020. "Intermediation in Over-the-Counter Markets with Price Transparency," Working Papers 202017, University of Hawaii at Manoa, Department of Economics.
    14. Jérôme Dugast & Semih Uslu & Pierre-Olivier Weil, 2018. "Platform Trading with an OTC Market Fringe," Post-Print hal-02104107, HAL.
    15. Benjamin Lester & Roc Armenter, 2015. "Excess Reserves and Monetary Policy Normalization," 2015 Meeting Papers 586, Society for Economic Dynamics.
    16. Derek Stacey, 2019. "Posted Prices, Search and Bargaining," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 85-104, July.
    17. Randall Wright & Philipp Kircher & Benoit Julîen & Veronica Guerrieri, 2017. "Directed Search: A Guided Tour," NBER Working Papers 23884, National Bureau of Economic Research, Inc.
    18. Goldstein, Michael A. & Hotchkiss, Edith S., 2020. "Providing liquidity in an illiquid market: Dealer behavior in US corporate bonds," Journal of Financial Economics, Elsevier, vol. 135(1), pages 16-40.
    19. Pierre-Olivier Weill, 2020. "The search theory of OTC markets," NBER Working Papers 27354, National Bureau of Economic Research, Inc.
    20. Shengxing Zhang & Briana Chang, 2015. "Endogenous Market-making and Formation of Trading Links," 2015 Meeting Papers 1227, Society for Economic Dynamics.

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    More about this item

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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