Why Trade Over-the-Counter?

60 Pages Posted: 13 Dec 2017 Last revised: 16 Nov 2022

See all articles by Tomy Lee

Tomy Lee

Central European University

Chaojun Wang

University of Pennsylvania - The Wharton School

Multiple version iconThere are 2 versions of this paper

Date Written: February 5, 2018

Abstract

Over-the-counter trading thrives despite opposing regulatory pressure. In our model, traders who pose a lower adverse selection risk optimally choose the OTC market, where a dealer can offer a trader-specific discount. Closing the OTC market forces some traders to exit but induces others with larger gains from trade to enter. Overall, trade volume falls, average bid-ask spread widens, and yet welfare rises if the asset is mostly OTC-traded. An easy-to-implement Pigouvian tax strictly improves welfare over closing the OTC market. We predict that the exchange's spread is wider than the OTC spread and positively correlated with its market share.

Keywords: Over-the-counter, exchanges, adverse selection, price discrimination, venue choice, name give-up, permissioned blockchain

JEL Classification: D47, D61, D82, G14, G18

Suggested Citation

Lee, Tomy and Wang, Chaojun, Why Trade Over-the-Counter? (February 5, 2018). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper , Available at SSRN: https://ssrn.com/abstract=3087647 or http://dx.doi.org/10.2139/ssrn.3087647

Tomy Lee (Contact Author)

Central European University ( email )

Quellenstrasse 51, C310
Vienna, Vienna 1100
Austria

HOME PAGE: http://https://sites.google.com/view/tomylee/home

Chaojun Wang

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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