Federal Reserve Bank of Philadelphia
Frictional Intermediation in Over-the-Counter Markets
We extend Duffie, Gˆarleanu, and Pedersen’s (2005) search theoretic model of over-the-counter (OTC) asset markets, allowing for a decentralized inter-dealer market with arbitrary heterogeneity in dealers’ valuations or inventory costs. We develop a solution technique that makes the model fully tractable and allows us to derive, in closed form, theoretical formulas for key statistics analyzed in empirical studies of the intermediation process in OTC markets. A calibration to the market for municipal securities reveals that the model can generate trading patterns and prices that are quantitatively consistent with the data. We use the calibrated model to compare the gains from trade that are realized in this frictional market with those from a hypothetical, frictionless environment, and to distinguish between the quantitative implications of various types of heterogeneity across dealers.
Cite this item
Julien Hugonnier & Benjamin Lester & Pierre-Olivier Weill, Frictional Intermediation in Over-the-Counter Markets, Federal Reserve Bank of Philadelphia, Working Papers 19-10, 31 Jan 2019.
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
Keywords: Over-the-counter markets; search frictions; bargaining; heterogeneous agents; intermediation
This item with handle RePEc:fip:fedpwp:19-10
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