Signaling in OTC Markets: Benefits and Costs of Transparency

Kerry Back, Ruomeng Liu and Alberto Teguia

Journal of Financial and Quantitative Analysis, 2020, vol. 55, issue 1, 47-75

Abstract: We provide a theoretical rationale for dealer objections to ex post transparency in over-the-counter markets. Disclosure of the terms of a transaction conveys information possessed by the dealer about the asset quality and reduces the dealer’s rents when she disposes of the inventory in a second transaction. We show that costly signaling in a transparent market benefits investors through lower spreads and higher volume. Dealers may also gain from transparency despite lower spreads when potential gains from trade are small or adverse selection is high, because in those circumstances higher volume offsets smaller spreads for dealer profits.

Date: 2020
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