Over-the-Counter Markets

Authors

  • Darrell Duffie,

    1. Graduate School of Business, Stanford University, Stanford, CA 94305-5015, U.S.A.; duffie@stanford.edu,
      Wharton School, University of Pennsylvania, 3620 Locust Walk, Philadelphia, PA 19104-6367, U.S.A.; garleanu@wharton.upenn.edu,
      and
      Stern School of Business, New York University, 44 West Fourth Street, Suite 9-190, New York, NY 10012-1126, U.S.A; lpederse@stern.nyu.edu.
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  • Nicolae Gârleanu,

    1. Graduate School of Business, Stanford University, Stanford, CA 94305-5015, U.S.A.; duffie@stanford.edu,
      Wharton School, University of Pennsylvania, 3620 Locust Walk, Philadelphia, PA 19104-6367, U.S.A.; garleanu@wharton.upenn.edu,
      and
      Stern School of Business, New York University, 44 West Fourth Street, Suite 9-190, New York, NY 10012-1126, U.S.A; lpederse@stern.nyu.edu.
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  • Lasse Heje Pedersen

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    • Part of this paper was previously distributed under the title “Valuation in Dynamic Bargaining Markets.” We are grateful for conversations with Yakov Amihud, Helmut Bester, Joseph Langsam of Morgan Stanley Dean Witter, Richard Lyons, Tano Santos, and Jeff Zwiebel, and to participants at the NBER Asset Pricing Meeting, the Cowles Foundation Incomplete Markets and Strategic Games Conference, the Western Finance Association Conference, the CEPR meeting at Gerzensee, University College London, Universite Libre de Bruxelles, Tel Aviv University, and Universitat Autonoma de Barcelona.


Abstract

We study how intermediation and asset prices in over-the-counter markets are affected by illiquidity associated with search and bargaining. We compute explicitly the prices at which investors trade with each other, as well as marketmakers' bid and ask prices, in a dynamic model with strategic agents. Bid–ask spreads are lower if investors can more easily find other investors or have easier access to multiple marketmakers. With a monopolistic marketmaker, bid–ask spreads are higher if investors have easier access to the marketmaker. We characterize endogenous search and welfare, and discuss empirical implications.

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