Private Information in Over-the-Counter Markets
Abstract: We study trading in over-the-counter (OTC) markets where agents have heterogeneous and private valuations for assets. We develop a quantitative model in which assets are issued through a primary market and then traded in a secondary OTC market. Then we use data on the US municipal bond market to calibrate the model. We find that the effects of private information are large, reducing asset supply by 20%, trade volume by 80%, and aggregate welfare by 8%. Using the model, we identify two channels through which the information friction harms the economy. First, the distribution of the existing stock of assets is inefficient because some of the efficient trades, which should occur, do not. Second, the total stock of assets is inefficiently low because resale value and liquidity go down due to the information friction. We investigate how much a simple tax/subsidy scheme that spurs issuance of new assets can help mitigate the cost associated with private information and find that it lowers the welfare cost from 8% to approximately 1%.
File format is application/pdf
Description: Full text
Provider: Federal Reserve Bank of Richmond
Part of Series: Working Paper
Publication Date: 2016-12-21
Pages: 46 pages