Private Information in Over-the-Counter Markets

Posted: 22 Dec 2016

See all articles by Zachary Bethune

Zachary Bethune

University of Virginia - Department of Economics

Bruno Sultanum

Federal Reserve Banks - Federal Reserve Bank of Richmond

Nicholas Trachter

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: 2016-12-21

Abstract

We study trading in over-the-counter (OTC) markets where agents have heterogeneous and private valuations for assets. We develop a quantitative model in which assets are issued through a primary market and then traded in a secondary OTC market. Then we use data on the US municipal bond market to calibrate the model. We find that the effects of private information are large, reducing asset supply by 20%, trade volume by 80%, and aggregate welfare by 8%. Using the model, we identify two channels through which the information friction harms the economy. First, the distribution of the existing stock of assets is inefficient because some of the efficient trades, which should occur, do not. Second, the total stock of assets is inefficiently low because resale value and liquidity go down due to the information friction. We investigate how much a simple tax/subsidy scheme that spurs issuance of new assets can help mitigate the cost associated with private information and find that it lowers the welfare cost from 8% to approximately 1%.

Keywords: Decentralized markets, bilateral trade, asset issuance, liquidity, asymmetric information

JEL Classification: D53, D82, G14

Suggested Citation

Bethune, Zachary and Sultanum, Bruno and Trachter, Nicholas, Private Information in Over-the-Counter Markets (2016-12-21). FRB Richmond Working Paper No. 16-16. Available at SSRN: https://ssrn.com/abstract=2888777

Zachary Bethune (Contact Author)

University of Virginia - Department of Economics ( email )

Bruno Sultanum

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Nicholas Trachter

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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