Endogenous Market Making and Network Formation

41 Pages Posted: 29 Apr 2015 Last revised: 22 Feb 2019

See all articles by Briana Chang

Briana Chang

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Shengxing Zhang

London School of Economics (LSE) - Department of Economics

Date Written: July 1, 2018

Abstract

This paper develops a dynamic trading framework that determines jointly agents' counterparties and transaction prices as part of the equilibrium, instead of assuming that agents match and bargain exogenously. We show that because of limited information in the decentralized market, the roles of market makers or customers emerge endogenously: certain agents specialize in market making and become highly interconnected, forming the core of the financial network. Having a model with endogenous trading links and transaction prices allows us to show that such a highly asymmetric market structure is constrained efficient, as market makers are compensated correctly for their services. It also allows us to obtain new insights regarding market resilience and intermediation costs.

Keywords: Trading Network, Over-the-Counter Market, Intermediation

JEL Classification: C70, G1, G20

Suggested Citation

Chang, Briana and Zhang, Shengxing, Endogenous Market Making and Network Formation (July 1, 2018). Available at SSRN: https://ssrn.com/abstract=2600242 or http://dx.doi.org/10.2139/ssrn.2600242

Briana Chang

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States

Shengxing Zhang (Contact Author)

London School of Economics (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

HOME PAGE: http://https://sites.google.com/site/oo7zsx/

Register to save articles to
your library

Register

Paper statistics

Downloads
954
Abstract Views
3,646
rank
23,753
PlumX Metrics