Asset Issuance in Over-the-Counter Markets

46 Pages Posted: 23 Oct 2017 Last revised: 15 Nov 2018

See all articles by Zachary Bethune

Zachary Bethune

University of Virginia

Bruno Sultanum

Federal Reserve Banks - Federal Reserve Bank of Richmond

Nicholas Trachter

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: 2017-10-20

Abstract

We model asset issuance in over-the-counter markets. Investors buy newly issued assets in a primary market and trade existing assets in a secondary market, where both markets are over the counter. We show that the level of asset issuance and its efficiency depend on how investors split the surplus in secondary market trade. If buyers get most of the surplus in secondary market trade, then sellers do not have incentives to participate in the primary market in order to intermediate assets and the economy has a low level of assets. On the other hand, if sellers get most of the surplus, buyers have strong incentives to participate in the primary market and the economy has a high level of assets. Equilibrium is inefficient for any splitting rule. The result follows from a double-sided hold-up problem in which it is impossible for all investors to take into account the full social value of an asset when trading. We propose a tax/subsidy scheme and show how it restores efficiency. We calibrate our model to match features of the US municipal bond market in order to quantify the effects of the intervention. The intervention leads to large welfare gains and, in response to a financial crisis caused by an aggregate demand shock, makes the crisis less severe and shorter relative to the economy with no intervention.

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

JEL Classification: D53, D82, G14

Suggested Citation

Bethune, Zachary and Sultanum, Bruno and Trachter, Nicholas, Asset Issuance in Over-the-Counter Markets (2017-10-20). FRB Richmond Working Paper No. 17-13. Available at SSRN: https://ssrn.com/abstract=3056595

Zachary Bethune (Contact Author)

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

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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