From Market Making to Matchmaking: Does Bank Regulation Harm Market Liquidity?

65 Pages Posted: 16 Jun 2019 Last revised: 13 Oct 2020

See all articles by Gideon Saar

Gideon Saar

Cornell University - Samuel Curtis Johnson Graduate School of Management

Jian Sun

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Ron Yang

Harvard University - Business School (HBS)

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: September 30, 2020

Abstract

Post-crisis bank regulations raised market-making costs for bank-affiliated dealers. We show that this can, somewhat surprisingly, improve overall investor welfare and reduce average transaction costs despite the increased cost of immediacy. Bank dealers in OTC markets optimize between two parallel trading mechanisms: market making and matchmaking. Bank regulations that increase market-making costs change the market structure by intensifying competitive pressure from non-bank dealers and incentivizing bank dealers to shift their business toward matchmaking. Thus, post-crisis bank regulations have the (unintended) benefit of replacing costly bank balance sheets with a more efficient form of financial intermediation.

Keywords: bank regulation, financial crisis, corporate bonds, liquidity, over-the-counter markets, broker-dealers, Basel 2.5, Basel III, Volcker Rule, post-crisis regulation, market making, matchmaking, market microstructure

JEL Classification: G01, G12, G21, G24, G28

Suggested Citation

Saar, Gideon and Sun, Jian and Yang, Ron and Zhu, Haoxiang, From Market Making to Matchmaking: Does Bank Regulation Harm Market Liquidity? (September 30, 2020). Available at SSRN: https://ssrn.com/abstract=3399063 or http://dx.doi.org/10.2139/ssrn.3399063

Gideon Saar (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

431 Sage Hall
Ithaca, NY 14853
United States
607-255-7484 (Phone)
607-255-5993 (Fax)

HOME PAGE: https://www.johnson.cornell.edu/Faculty-And-Research/Profile?id=gs25

Jian Sun

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
Cambridge, MA 02142
United States

Ron Yang

Harvard University - Business School (HBS) ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street E62-623
Cambridge, MA 02142
United States

HOME PAGE: http://www.mit.edu/~zhuh

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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