Discussion Paper

How Does Information Affect Liquidity in Over-the-Counter Markets?

Abstract: A large volume of financial transactions occur in decentralized markets that commonly depend on a network of dealers. Dealers face two impediments to providing liquidity in these markets. First, dealers may face informed traders. Second, they may face costs associated with maintaining large balance sheets, either due to inventory or liquidity costs. In a recent paper, we study a model of over-the-counter (OTC) markets in which liquidity is endogenously determined by dealers who must contend with both asymmetric information and liquidity costs. This post provides an intuitive explanation of our model and the dynamics of interdealer liquidity.

Keywords: Liquidity; information; inter-dealer;

JEL Classification: G1; G14;

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Liberty Street Economics

Publication Date: 2020-01-13

Number: 20200113