DP10237 Dealer Networks
|Author(s):||Dan Li, Norman Schürhoff|
|Publication Date:||November 2014|
|Keyword(s):||decentralization, immediacy, liquidity, market quality, municipal bonds, network analysis, over-the-counter financial market, trading cost, transparency|
|JEL(s):||G12, G14, G24|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=10237|
Dealers in over-the-counter securities form networks to mitigate search frictions. The audit trail for municipal bonds shows the dealer network has a core-periphery structure. Central dealers are more efficient at matching buyers and sellers than peripheral dealers, which shortens intermediation chains and speeds up trading. Investors face a tradeoff between execution speed and cost. Central dealers provide immediacy by pre-arranging fewer trades and holding larger inventory. However, trading costs increase strongly with dealer centrality. Investors with strong liquidity need trade with central dealers and at times of market-wide illiquidity. Central dealers thus serve as liquidity providers of last resort.