Inventory Management, Dealers' Connections, and Prices in OTC Markets
60 Pages Posted: 10 Jul 2018 Last revised: 13 Dec 2019
Date Written: December 13, 2019
We propose a new model of trading in OTC markets. Dealers accumulate inventories by trading with end-investors and trade among each other to reduce their inventory holding costs. Core dealers have access to a more efficient trading technology than peripheral dealers, who are heterogeneously connected to core dealers and trade with each other bilaterally. Connectedness affects prices and allocations if and only if the peripheral dealers' aggregate inventory position differs from zero. The resulting price dispersion increases in the size of this position. The model generates new predictions about the joint effects of peripheral dealers' connectedness and dealers' aggregate inventories on transaction prices, both among dealers and between dealers and their clients.
Keywords: OTC markets, Interdealer trading, Inventory management
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