Frictional Intermediation in Over-the-Counter Markets
80 Pages Posted: 6 Feb 2019 Last revised: 29 Apr 2020
Date Written: 2019-01-31
We extend Duffie, GË†arleanu, and Pedersenâ€™s (2005) search theoretic model of over-the-counter (OTC) asset markets, allowing for a decentralized inter-dealer market with arbitrary heterogeneity in dealersâ€™ valuations or inventory costs. We develop a solution technique that makes the model fully tractable and allows us to derive, in closed form, theoretical formulas for key statistics analyzed in empirical studies of the intermediation process in OTC markets. A calibration to the market for municipal securities reveals that the model can generate trading patterns and prices that are quantitatively consistent with the data. We use the calibrated model to compare the gains from trade that are realized in this frictional market with those from a hypothetical, frictionless environment, and to distinguish between the quantitative implications of various types of heterogeneity across dealers.
Keywords: Over-the-counter markets, search frictions, bargaining, heterogeneous agents, intermediation
JEL Classification: G11, G12, G21
Suggested Citation: Suggested Citation