Discussion Paper Details

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Title: Trading and information diffusion in OTC markets

Author(s): Ana Babus and Péter Kondor

Publication Date: January 2013

Keyword(s): bilateral trading, demand schedule equilibrium, information aggregation, networks and over-the-counter markets

Programme Area(s): Financial Economics

Abstract: We model trading and information diffusion in OTC markets, when dealers can engage in many bilateral transactions at the same time. We show that information diffusion is effective, but not efficient. While each bilateral price partially reveals all dealers' private information after a single round of trading, dealers could learn more even within the constraints imposed by our environment. This is not a result of dealers' market power, but arises from the interaction between decentralization and differences in dealers' valuation of the asset. We apply our framework to confront several explanations for the disruption of OTC markets with stylized facts from the empirical literature. We find more support for narratives emphasizing increased counterparty risk as opposed to increased informational frictions.

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Bibliographic Reference

Babus, A and Kondor, P. 2013. 'Trading and information diffusion in OTC markets'. London, Centre for Economic Policy Research.