Asset Heterogeneity, Market Fragmentation, and Quasi-Consolidated Trading

Abstract

Asset heterogeneity is widely believed to hurt the liquidity in markets of many important fixed-income assets such as corporate and municipal bonds. We develop a model in which heterogeneous assets are traded with search friction to study the impact of a quasi-consolidated (QC) trading design in which a cohort of heterogeneous assets are sold at the same price. In the model, asset heterogeneity results in market fragmentation and exacerbates search frictions, thereby undermining market liquidity. We show that QC trading reduces market fragmentation and improves the overall market liquidity by pooling multiple sellers and buyers together. Nevertheless, because of asset heterogeneity, QC trading in general hurts some traders and cannot fully eliminate market fragmentation. Integrating QC contracts for multiple types of assets improves (hurts) overall market liquidity when these types of assets differ slightly (significantly) in value distribution.

Keywords: Asset Heterogeneity, Corporate Bonds, Quasi-Consolidated Trading, TBA, MBS, Search

JEL Classification: G1, G11, G12, G21, D83, D53, D61