Intermediary Market Power and Capital Constraints
62 Pages Posted: 6 Apr 2022 Last revised: 14 Jul 2023
Date Written: June 1, 2021
Abstract
We examine how intermediary capitalization affects asset prices in a framework that allows for intermediary market power. We introduce a model in which capital constrained intermediaries buy or trade an asset in an imperfectly competitive market, and show that weaker capital constraints lead to both higher prices and intermediary markups. In exchange markets, this results in reduced market liquidity, while in primary markets, it leads to higher auction revenues at an implicit cost of larger price distortion. Using data from Canadian Treasury auctions, we demonstrate how our framework can quantify these effects by linking asset demand to individual intermediaries' balance sheet information.
Keywords: Financial intermediaries, asset demand, asset prices, government bonds, capital requirements, leverage ratios
JEL Classification: G12, G18, G20, D40, D44, L10
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