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Competing for Order Flow in OTC Markets

Author

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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 that offer the most attractive terms. We characterize the equilibrium in a general setting, and illustrate how the model can account for several important trading patterns in over-the-counter markets which do not emerge from existing models. We then study two special cases which allow us to highlight the differences between these existing models, which assume investors engage in random search for dealers and then use ex post bargaining to determine prices, and our model, which utilizes the concept of competitive search in which dealers post terms of trade. Finally, we calibrate our model, illustrate that it generates reasonable quantitative outcomes, and use it to study how trading frictions affect the per-unit trading costs that investors pay in equilibrium.

Suggested Citation

  • Benjamin Lester & Guillaume Rocheteau & Pierre-Olivier Weill, 2014. "Competing for Order Flow in OTC Markets," NBER Working Papers 20608, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:20608
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Briana Chang & Shengxing Zhang, 2015. "Endogenous Market Making and Network Formation," Discussion Papers 1534, Centre for Macroeconomics (CFM).
    2. 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.
    3. Benjamin Lester & Roc Armenter, 2015. "Excess Reserves and Monetary Policy Normalization," 2015 Meeting Papers 586, Society for Economic Dynamics.
    4. Derek G. Stacey, 2015. "Posted Prices, Search and Bargaining," Working Papers 059, Ryerson University, Department of Economics, revised Dec 2017.
    5. Dan LI & Norman SCHUERHOFF, "undated". "Dealer Networks," Swiss Finance Institute Research Paper Series 14-50, Swiss Finance Institute.
    6. Shen, Ji & Wei, Bin & Yan, Hongjun, 2016. "Financial Intermediation Chains in an OTC Market," MPRA Paper 74925, University Library of Munich, Germany.
    7. Kurmann, André & Rabinovich, Stanislav, 2018. "Dynamic inefficiency in decentralized capital markets," Journal of Economic Theory, Elsevier, vol. 173(C), pages 231-256.
    8. Uslu, Semih, 2015. "Pricing and Liquidity in Decentralized Asset Markets," MPRA Paper 73901, University Library of Munich, Germany, revised 21 Sep 2016.
    9. 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.
    10. repec:eee:jetheo:v:174:y:2018:i:c:p:16-56 is not listed on IDEAS
    11. Shengxing Zhang & Briana Chang, 2015. "Endogenous Market-making and Formation of Trading Links," 2015 Meeting Papers 1227, Society for Economic Dynamics.
    12. 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.

    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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