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Dealer Networks

Dan Li

Federal Reserve Board

Norman Schürhoff

University of Lausanne; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)

March 15, 2012

We use the MSRB Transaction Reporting System audit trail to study the impact of dealer centrality on trading costs and liquidity provision in opaque over-the-counter markets. The dealership network in municipal bonds exhibits a hierarchical core-periphery structure with around 30 highly interconnected dealers at its core and several hundred peripheral dealer firms. Execution quality varies significantly across dealers depending on their centrality within the trading network. Central dealers charge larger trading costs to investors and face lower loss probabilities than peripheral dealers. Yet, more investor orders flow through central dealers. Informational efficiency increases with centrality, mitigating adverse selection risk. Dealers experience significant liquidity spillover from connected dealers, leading central dealers to hold larger and more volatile inventories on average and to keep bonds longer than peripheral dealers. Centrality thereby improves dealers' negotiating position with investors. This explains why competition is fierce at the periphery but not at the core of the decentralized market. These results demonstrate the trade-offs investors face when trading in over-the-counter markets, which may guide financial market design.

Number of Pages in PDF File: 46

Keywords: Municipal bond market, over-the-counter financial market, market quality, liquidity spillover, network analysis

JEL Classification: G12, G14, G24

working papers series

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Date posted: March 16, 2012  

Suggested Citation

Li, Dan and Schürhoff, Norman, Dealer Networks (March 15, 2012). Available at SSRN: http://ssrn.com/abstract=2023201 or http://dx.doi.org/10.2139/ssrn.2023201

Contact Information

Dan Li (Contact Author)
Federal Reserve Board ( email )
20th and C Streets, NW
Mail Stop 89
Washington, DC 20551
United States
Norman Schürhoff
University of Lausanne ( email )
Extranef 228
CH-1015 Lausanne
+41 (0)21 692 3447 (Phone)
+41 (0)21 692 3435 (Fax)
Swiss Finance Institute ( email )
c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Centre for Economic Policy Research (CEPR) ( email )
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
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References:  25
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