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Platform Trading with an OTC Market Fringe

Author

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  • Jérôme Dugast
  • Semih Uslu
  • Pierre-Olivier Weil

    (University of California - University of California)

Abstract

We study the privately and socially optimal participation of investors in a centralizedplatform or in an over-the-counter (OTC) market. Investors incur costs to trade in theplatform, in the OTC market, or in both at the same time. Investors differ from eachother in risk-sharing needs and OTC market trading capacities. We show that investorswith low risk-sharing needs and large trading capacities endogenously emerge as OTCintermediaries, and have the strongest private incentives to enter the OTC market vs. thetrading platform. Investors with strong risk-sharing needs and low trading capacities endogenously emerge as OTC customers, and have the weakest private incentive to enterthe OTC market vs. the trading platform. Turning to social welfare, we provide twonecessary conditions for customers' private incentives to be excessively large relative totheir social contribution. Mandating or subsidizing trade in a centralized venue can bewelfare improving only if these conditions are satisfied. First, investors must differ mostlyin terms of OTC trading capacities. Second, participation costs must induce exclusiveparticipation decisions. Based on the empirical trading patterns generated by closed-formexamples of our model, we argue that the real-world OTC markets might satisfy thec onditions under which mandating or subsidizing centralized trade is welfare improving.

Suggested Citation

  • Jérôme Dugast & Semih Uslu & Pierre-Olivier Weil, 2018. "Platform Trading with an OTC Market Fringe," Post-Print hal-02104107, HAL.
    • Handle: RePEc:hal:journl:hal-02104107
    Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-02104107
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    References listed on IDEAS

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    1. 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.
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    7. Athanasios Geromichalos & Lucas Herrenbrueck, 2016. "Monetary Policy, Asset Prices, and Liquidity in Over‐the‐Counter Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(1), pages 35-79, February.
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    1. Ana Babus & Kinda Cheryl Hachem, 2019. "Markets for Financial Innovation," NBER Working Papers 25477, National Bureau of Economic Research, Inc.
    2. Babus, Ana & Hachem, Kinda, 2019. "Markets for Financial Innovation," CEPR Discussion Papers 13457, C.E.P.R. Discussion Papers.

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    Keywords

    over the counter; market; investements; payoff;

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