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Dealer costs and customer choice

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Abstract

We introduce a model to explain how an increase in intermediation costs leads to structural changes in the corporate bond market. We state three facts on corporate bond markets after the Dodd-Frank act: (1) an increase in customer liquidity provision through prearranged matches, (2) a paradoxical decrease in measured illiquidity, and (3) an increase in the illiquidity component on the yield spread. Investors take longer to finish a trade and require higher illiquidity premium even though measured illiquidity decreased. We introduce a search and matching model which explains these facts. It also suggests the possibility of multiple equilibria and financial instability when dealers face high costs to intermediate transactions.

Suggested Citation

  • Lucas Dyskant & André F. Silva & Bruno Sultanum, 2023. "Dealer costs and customer choice," Working Paper 23-13, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:97438
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    File URL: https://www.richmondfed.org/-/media/RichmondFedOrg/publications/research/working_papers/2023/wp23-13.pdf
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    More about this item

    Keywords

    over-the-counter markets; intermediation costs; liquidity; corporate bonds; Volcker rule; post-2008 regulation;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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