Pricing and Liquidity in Decentralized Asset Markets

Abstract

I develop a search‐and‐bargaining model of endogenous intermediation in over‐the‐counter markets. Unlike the existing work, my model allows for rich investor heterogeneity in three simultaneous dimensions: preferences, inventories, and meeting rates. By comparing trading‐volume patterns that arise in my model and are observed in practice, I argue that the heterogeneity in meeting rates is the main driver of intermediation patterns. I find that investors with higher meeting rates (i.e., fast investors) are less averse to holding inventories and more attracted to cash earnings, which makes the model corroborate a number of stylized facts that do not emerge from existing models: (i) fast investors provide intermediation by charging a speed premium, and (ii) fast investors hold more extreme inventories. Then, I use the model to study the effect of trading frictions on the supply and price of liquidity. On social welfare, I show that the interaction of meeting rate heterogeneity with optimal inventory management makes the equilibrium inefficient. I provide a financial transaction tax/subsidy scheme that corrects this inefficiency, in which fast investors cross‐subsidize slow investors.

OTC Discount

“…Theories of such markets focus on searchand-bargaining frictions to explain pricing di↵erences (e.g. Du e, Pedersen, 2005, 2007;Üslü, 2019;Hugonnier, Lester and Weill, 2020). The empirical literature has confirmed the relevance of these frictions, for example with regard to dealer network structure (Li and Schürho↵, 2019) and systematic changes in yield spreads (Friewald and Nagler, 2019).…”

A Model of Trading in the Art Market

“…3 Some recent papers in this literature show patterns of trade and intermediation that are less trivial, for example because agents do not only differ in their valuations but also in their search intensities (Uslü 2016;Farboodi, Jarosch, and Shimer 2017) or their ability to commit to take-it-or-leave-it offers (Farboodi, Jarosch, and Menzio 2017). A number of studies have applied the search-and-bargaining framework to other "real asset" markets.…”

What Factors Influence European Corporate Bond Spread?

“…Liquidity impacts financial market prices (Collin-Dufresne et al 2001;Chung and Hrazdil, 2010;Jacoby et al 2000;Kondor & Vayanos, 2019;Üslü, 2019). In general, the lack of liquidity is a negative component of asset price and therefore affects asset returns (Amihud & Mendelson 1989;Brennan et al 1998;Chen et al, 2018Chen et al, , 2007Grossman and Miller, 1988;Huang and Wang, 2009;Lin et al 2011).…”