Dealer Expertise and Market Concentration in OTC Trading

42 Pages Posted: 7 Jul 2020 Last revised: 24 Jan 2024

See all articles by Wei Li

Wei Li

CUNY Baruch College

Zhaogang Song

Johns Hopkins University - Carey Business School

Date Written: 2020

Abstract

We endogenize dealer expertise and market structure in a model of over-the-counter markets in which each customer values dealers' expertise in producing information on a risky asset's value and chooses one dealer to trade with. When more customers concentrate in a dealer, the dealer acquires more expertise and also enjoys greater market power, with the former benefiting whereas the latter hurting her customers. Ex-ante identical dealers can differ in expertise level and size in equilibrium. Our model generates a positive association of dealers' expertise, size, and bid-ask spreads they charge. Further, while social welfare increases with customers' concentration, customers themselves fare better with intermediate levels of concentration. In addition, improving transparency tends to lower market concentration, improve liquidity, and reduce price dispersion. Less-efficient dealers can capture larger market shares.

Keywords: Bilateral Trading, Dealer, Expertise, Network, OTC, Private Information

JEL Classification: G11, G12, G21

Suggested Citation

Li, Wei and Song, Zhaogang, Dealer Expertise and Market Concentration in OTC Trading (2020). Johns Hopkins Carey Business School Research Paper No. 22-03, Available at SSRN: https://ssrn.com/abstract=3624307 or http://dx.doi.org/10.2139/ssrn.3624307

Wei Li

CUNY Baruch College ( email )

17 Lexington Avenue
New York, NY 10021
United States

Zhaogang Song (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

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