Over-the-Counter vs. Limit-Order Markets: The Role of Traders' Expertise
64 Pages Posted: 3 Dec 2015 Last revised: 9 Nov 2018
Date Written: November 8, 2018
Over-the-counter (OTC) markets attract substantial trading volume despite exhibiting frictions absent in centralized limit-order markets. We compare the efficiency of OTC and limit-order markets when traders' expertise is endogenous. We show that asymmetric access to counterparties in OTC markets yields increased rents to expertise acquisition for a few well-connected core traders. When the existence of gains to trade is uncertain, traders' higher expertise in OTC markets can improve allocative efficiency. In contrast, when expertise primarily causes adverse selection, competitive limit-order markets tend to dominate. Our model provides guidance for policymakers and empiricists evaluating the efficiency of market structures.
Keywords: Asymmetric Information, OTC Trading, Centralized Markets, Rent-seeking, Market Power
JEL Classification: D82, G23, L10
Suggested Citation: Suggested Citation