Intermediation in Over-the-Counter Markets with Price Transparency; Miroslav Gabrovski (Hawaii at Manoa)

Abstract

A salient feature of over-the-counter (OTC) markets is intermediation: dealers buy from and sell to customers as well as other dealers. Traditionally, the search-theoretic literature of OTC markets has rationalized this as a consequence of random meetings and ex post bargaining between investors. We show that neither of these are necessary conditions for intermediation. We build a model of a fully decentralized OTC market in which search is directed and sellers post prices ex ante. Intermediation arises naturally as an equilibrium outcome for a broad class of matching functions commonly used in the literature. We also explore the sorting implications of the equilibrium pattern of trade and show that it is constrained efficient.

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