Trading Choices

Abstract

We propose a model of over-the-counter markets based on three trading methods: principal inventory, agency risk-free, and all-to-all (A2A) trading. Principal and agency trading occur through dealers. A2A trading occurs directly through customer-customer trading. The model predicts that A2A size can remain stable while principal and agency trading change. Higher inventory costs shifts trading from principal to agency and decrease dealers' net positions. Bid-ask spreads can decrease even though transaction costs increase. High transaction costs can lead to multiple equilibria. The model shows how regulatory and technological changes affect trading choices, stability, and market indicators.

Keywords: intermediation costs, liquidity, corporate bond markets, financial market regulations, post-2008 regulations, Volcker rule

JEL Classification: D53, G12, G18, G28