Which Inter-Dealer Market Prevails? An Analysis of Inter-Dealer Trading in Opaque Markets

Abstract

A number of dealership markets share three common features: customer-dealer trades remain undisclosed, inter-dealer trading forms a substantial part of total trading and dealers have a choice, when dealing with each other, between doing so directly and using an inter-dealer broker (IDB). Using a three-stage market microstructure model, we show that for dealers who have executed undisclosed customer trades, their choice depends on the number of firms who operate as dealers: trading through the IDB being preferable when more than a critical number of dealers participate in the industry and vice versa. Comparative static effects of information asymmetry and market transparency on the critical number of dealers are derived. Subject to a monotonicity constraint, a condition is derived determining which form of inter-dealer market will prevail.

JEL Classification: G14