Brokers or Dealers? Trading Intermediation and Market Liquidity

52 Pages Posted: 17 Apr 2016 Last revised: 28 Oct 2022

See all articles by Jiacui Li

Jiacui Li

David Eccles School of Business, University of Utah

Wenhao Li

University of Southern California - Marshall School of Business

Date Written: June 24, 2020

Abstract

Investors can execute trades through either brokers that trade on their behalf (agency intermediation) or dealers that trade with them (principal intermediation). We explain the heterogeneity in intermediation via the trade-off between monitoring brokers and incurring dealer inventory costs. Brokers do not internalize execution outcomes and thus require monitoring. Dealers internalize outcomes but face inventory costs. Consistent with model predictions, agency intermediation is more prevalent in transparent and liquid markets; when intermediary capital cost increases, principal intermediation is replaced by agency intermediation. Our theory implies that improving market transparency can alleviate the pressure of tightening capital regulations on market liquidity.

Keywords: Intermediaries, Agency Trading, Principal Trading, Price Benchmark, Market Transparency

JEL Classification: C73, L14, G12

Suggested Citation

Li, Jiacui and Li, Wenhao, Brokers or Dealers? Trading Intermediation and Market Liquidity (June 24, 2020). Available at SSRN: https://ssrn.com/abstract=2760457 or http://dx.doi.org/10.2139/ssrn.2760457

Jiacui Li (Contact Author)

David Eccles School of Business, University of Utah ( email )

HOME PAGE: http://https://www.jiacui-li.com/

Wenhao Li

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA California 90089
United States

HOME PAGE: http://www.wenhao-li.com

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