Dealer Funding and Market Liquidity

76 Pages Posted: 8 Nov 2018 Last revised: 10 Sep 2021

See all articles by Max Bruche

Max Bruche

Humboldt University of Berlin

John Chi-Fong Kuong

INSEAD - Finance

Multiple version iconThere are 2 versions of this paper

Date Written: September 10, 2021

Abstract

We consider a model in which dealers intermediate trades between clients and provide immediacy, or, market liquidity. Dealers can exert unobservable search effort to improve the chance of intermediating profitably. This moral-hazard friction impairs dealers’ ability to raise external finance and hence to compete aggressively with each other in providing liquidity. Market liquidity is limited even for safe assets and more so for assets with higher search cost. To alleviate the financing friction, dealers opt to finance with debt and intermediate in several markets simultaneously. Dealer leverage is therefore endogenous and related to variations in liquidity across otherwise unrelated markets. Our results shed light on how post-crisis regulations influence the provision of immediacy in bond markets.

Keywords: dealers, market liquidity, immediacy, regulation, optimal contract.

JEL Classification: G12, G23, G24, G28

Suggested Citation

Bruche, Max and Kuong, John Chi-Fong, Dealer Funding and Market Liquidity (September 10, 2021). Available at SSRN: https://ssrn.com/abstract=3281303 or http://dx.doi.org/10.2139/ssrn.3281303

Max Bruche

Humboldt University of Berlin ( email )

Spandauer Str. 1
Berlin, D-10099
Germany

HOME PAGE: http://www.maxbruche.net

John Chi-Fong Kuong (Contact Author)

INSEAD - Finance ( email )

Boulevard de Constance
77305 Fontainebleau Cedex
France

HOME PAGE: http://www.johncfkuong.com

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