Dealer Specialization and Market Segmentation

74 Pages Posted: 30 Nov 2023

See all articles by Chotibhak Jotikasthira

Chotibhak Jotikasthira

Southern Methodist University (SMU) - Finance Department

Christian T. Lundblad

University of North Carolina Kenan-Flagler Business School; Frank Hawkins Kenan Institute of Private Enterprise

Jinming Xue

Southern Methodist University (SMU) - Finance Department

Date Written: November 18, 2023

Abstract

Using machine learning techniques, we uncover an important number of dealers in the U.S. municipal bond market who focus on geographically adjacent states, a characteristic distinct from dealer centrality. These “specialized” dealers enjoy larger market shares in states with greater local ownership and in local bonds with more complex features. We also find that trades intermediated by these specialized dealers have significantly larger markups than those intermediated by national dealers. For the average retail trade, about two-thirds of the differential markup is attributed to rent, with the remaining third to the unique benefits of specialization. Only the latter matters for institution-sized trades. Together, these results suggest that specialized dealers possess some monopoly power yet also provide important differentiated services. Specialized dealers provide immediacy, reward customers with an allocation of new bond offerings, help customers overcome information frictions, and facilitate access to local investor clientele. The latter two account for the bulk of the specialization benefits. Over time, as transparency improves and local ownership declines, the average market share of specialized dealers decreases along with differential markups.

Keywords: Municipal bonds, Over-the-counter market, Segmentation, Clientele effects, Dealer network, Geographical specialization, Liquidity

JEL Classification: G12, G14, G24

Suggested Citation

Jotikasthira, Chotibhak and Lundblad, Christian T. and Xue, Jinming, Dealer Specialization and Market Segmentation (November 18, 2023). Available at SSRN: https://ssrn.com/abstract=4636821 or http://dx.doi.org/10.2139/ssrn.4636821

Chotibhak Jotikasthira

Southern Methodist University (SMU) - Finance Department ( email )

United States

Christian T. Lundblad

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-8441 (Phone)

Frank Hawkins Kenan Institute of Private Enterprise ( email )

Campus Box 3440, The Kenan Center
Chapel Hill, NC 27599-344
United States

Jinming Xue (Contact Author)

Southern Methodist University (SMU) - Finance Department ( email )

United States
(214)-768-4181 (Phone)

HOME PAGE: http://sites.google.com/view/jinming-xue

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