Endogenous Specialization and Dealer Networks
70 Pages Posted: 19 Oct 2015 Last revised: 16 Aug 2018
Date Written: July 30, 2018
OTC markets exhibit a core-periphery network: 10-30 central dealers trade frequently and with many dealers, while hundreds of peripheral dealers trade sparsely and with few dealers. Existing work rationalize this phenomenon with exogenous dealer heterogeneity. We build a search-based model of network formation and propose that a core-periphery network arises from specialization. Dealers endogenously specialize in different clients with different liquidity needs. The clientele difference across dealers, in turn, generates dealer heterogeneity and the core-periphery network: The dealers specializing in clients who trade frequently form the core, while the dealers specializing in buy-and-hold investors form the periphery.
Keywords: network formation, core-periphery, clientele effect, specialization, intermediation chains, over-the-counter markets, search frictions
JEL Classification: G10
Suggested Citation: Suggested Citation