Inventory, market making, and liquidity in OTC markets

Assa Cohen, Mahyar Kargar, Benjamin Lester and Pierre-Olivier Weill

Journal of Economic Theory, 2024, vol. 222, issue C

Abstract: We develop a search-theoretic model of a dealer-intermediated over-the-counter market. Our key departure from the literature is to assume that, when a customer meets a dealer, the dealer can sell only assets that it already owns. Hence, in equilibrium, dealers choose to hold inventory. We derive the equilibrium relationship between dealers' costs of holding assets on their balance sheets, their optimal inventory holdings, and various measures of liquidity, including bid-ask spreads, trade size, volume, and turnover. Using transaction-level data from the corporate bond market, we calibrate the model to quantitatively assess the impact of post-crisis regulations on dealers' inventory costs, liquidity, and welfare.

Keywords: Over-the-counter markets; Intermediation; Liquidity; Dealer inventory; Financial regulation (search for similar items in EconPapers)
JEL-codes: G11 G12 G21 (search for similar items in EconPapers)
Date: 2024
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Working Paper: Inventory, Market Making, and Liquidity in OTC Markets (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:222:y:2024:i:c:s0022053124001236

DOI: 10.1016/j.jet.2024.105917

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