Asset Heterogeneity, Market Fragmentation, and Quasi-Consolidated Trading

47 Pages Posted: 14 Jul 2020 Last revised: 25 Oct 2023

See all articles by Wei Li

Wei Li

CUNY Baruch College

Zhaogang Song

Johns Hopkins University - Carey Business School

Date Written: June 20, 2020

Abstract

Large asset heterogeneity is one of the most salient features of over-the-counter (OTC) markets. We first demonstrate, in a benchmark model, that asset heterogeneity results in market fragmentation, limiting the beneficial network externality of liquidity. We then introduce quasi-consolidated (QC) contract---a mechanism that enables assets of heterogeneous values to be traded at a uniform price---into the benchmark model and show that it increases total trading volume and social welfare by reducing market fragmentation. Nevertheless, the uniform pricing of QC trading leads to a cheapest-to-deliver effect, which harms liquidity for sellers who do not adopt QC trading; it also lowers profits for these sellers and even some sellers who adopt QC trading. Our model lays a foundation for analyzing liquidity and design in OTC markets of heterogeneous assets.

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

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

Suggested Citation

Li, Wei and Song, Zhaogang, Asset Heterogeneity, Market Fragmentation, and Quasi-Consolidated Trading (June 20, 2020). Available at SSRN: https://ssrn.com/abstract=3631925 or http://dx.doi.org/10.2139/ssrn.3631925

Wei Li (Contact Author)

CUNY Baruch College ( email )

17 Lexington Avenue
New York, NY 10021
United States

Zhaogang Song

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

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