Dealer Networks

Abstract

Dealers in the over-the-counter municipal bond market form trading networks with other dealers to mitigate search frictions. Regulatory audit trail data show the dealer network has a core-periphery structure with 10 to 30 hubs and over 2,000 peripheral broker-dealers in which bonds flow in a chain from periphery to core and partially back. Central dealers charge up to double the roundtrip markups to investors compared to peripheral dealers. In turn, central dealers provide immediacy by matching buyers with sellers more directly and prearranging fewer trades than peripheral dealers, especially during stress times. Investors thus face a tradeoff between execution cost and speed, consistent with network models of decentralized trade.

Keywords: Municipal bonds, over-the-counter market, financial network, dealer centrality, trading cost, immediacy, liquidity

JEL Classification: G12, G14, G24