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Financial Intermediation and the Costs of Trading in an Opaque Market

FAME Research Paper No. 130

47 Pages Posted: 28 Feb 2005  

Richard C. Green

Carnegie Mellon University - David A. Tepper School of Business

Burton Hollifield

Carnegie Mellon University - David A. Tepper School of Business

Norman Schürhoff

University of Lausanne; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: Feburary 2005

Abstract

Municipal bonds trade in opaque, decentralized broker-dealer markets in which price information is costly to gather. Whether dealers in such a market operate competitively is an empirical issue, but a difficult one to study. Data in such markets is generally not centrally recorded. We analyze a comprehensive database of all trades between broker-dealers in municipal bonds and their customers. The data is only released to the public with a substantial lag, and thus the market was relatively opaque to the traders themselves during our sample period. We find that dealers earn lower average markups on larger trades, even though larger trades lead the dealers to bear more risk of losses. We formulate and estimate a simple structural bargaining model that allows us to estimate measures of dealer bargaining power and relate it to characteristics of the trades. The results suggest dealers exercise substantial market power. Our measures of market power decrease in trade size and increase in variables that indicate the complexity of the trade for the dealer.

Keywords: Municipal Bonds, Fixed Income Dealer, Transaction Costs, Liquidity, Transparency, Market Power

JEL Classification: D40, G14, G24, G28

Suggested Citation

Green, Richard C. and Hollifield, Burton and Schürhoff, Norman, Financial Intermediation and the Costs of Trading in an Opaque Market (Feburary 2005). FAME Research Paper No. 130. Available at SSRN: https://ssrn.com/abstract=668847 or http://dx.doi.org/10.2139/ssrn.668847

Richard C. Green (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

315B Schenley Park
Pittsburgh, PA 15213-3890
United States
412-268-2302 (Phone)
412-268-7064 (Fax)

Burton Hollifield

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
(412) 268-6505 (Phone)
(412) 268-6837 (Fax)

Norman Schürhoff

University of Lausanne ( email )

Extranef 228
CH-1015 Lausanne
Switzerland
+41 (0)21 692 3447 (Phone)
+41 (0)21 692 3435 (Fax)

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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