Working Paper

Dealer Networks

Abstract: Dealers in over-the-counter securities form networks to mitigate search frictions. The audit trail for municipal bonds shows the dealer network has a core-periphery structure. Central dealers are more efficient at matching buyers and sellers than peripheral dealers, which shortens intermediation chains and speeds up trading. Investors face a tradeoff between execution speed and cost. Central dealers provide immediacy by pre-arranging fewer trades and holding larger inventory. However, trading costs increase strongly with dealer centrality. Investors with strong liquidity need trade with central dealers and at times of market-wide illiquidity. Central dealers thus serve as liquidity providers of last resort.

Keywords: Municipal bonds; over-the-counter financial market; network analysis; trading costs; liquidity; immediacy; transparency;

JEL Classification: G12; G14; G24;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2014-11-10

Number: 2014-95

Pages: 68 pages