Financial Intermediation and the Costs of Trading in an Opaque Market

Richard C. Green, Burton Hollifield () and Norman Schürhoff
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Richard C. Green: Tepper School of Business, Carnegie Mellon University
Norman Schürhoff: HEC, University of Lausanne and FAME

FAME Research Paper Series from International Center for Financial Asset Management and Engineering

Abstract: Municipal bonds trade in opaque, decentralized broker-dealer markets in which price information is costly to gather. Whether dealers in such a market operate competitively is an empirical issue, but a difficult one to study. Data in such markets is generally not centrally recorded. We analyze a comprehensive database of all trades between broker-dealers in municipal bonds and their customers. The data is only released to the public with a substancial lag, and thus the market was relativela opaque to the traders themselves during our sample period. We find that dealers earn lower average markups on larger trades, even though larger trades lead the dealers to bear more risk of losses. We formulate and estimate a simple structural bargaining model that allows us to estimate mesures of dealer bargaining power and it relate it to the characteristics of the trades. The results suggest dealers exercise substancial market power. Our mesures of market power decrease in trade size and increase in variables that indicate the complexity of the trade for the dealer.

Keywords: Municipal Bonds; Fixed Income Dealer; Transaction Costs; Liquidity; Transparency; Market Power (search for similar items in EconPapers)
JEL-codes: D40 G14 G24 G28 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin
Date: 2005-02
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Working Paper: Financial Intermediation and the Costs of Trading in an Opaque Market
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