Endogenous Intermediation in Over-the-Counter Markets

Ana Babus and Tai-Wei Hu

No 10708, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We provide a theory of trading through intermediaries in OTC markets. The role of intermediaries is to sustain unsecured trade. When agents trade without collateral, total surplus can increase. In our model, traders are connected through a network. Agents observe their neighbors' actions, and can trade with their counterparty in a given period through a path of intermediaries in the network. If trade is unsecured, agents can renege on their obligations. We show that trading through a network is essential to support unsecured trade, when agents infrequently meet the same counterparty in the market. However, intermediaries must receive fees to have the incentive to implement unsecured trades. While trade without collateral can be sustained in many networks, the efficiency gains are higher in a star network. The center agent in a star can receive higher fees as well. Moreover, concentrated intermediation is a stable structure, when agents incur linking costs.

Keywords: Over-the-counter trading; Strategic default; Dynamic network formation (search for similar items in EconPapers)
JEL-codes: D85 G14 G21 (search for similar items in EconPapers)
Date: 2015-07
New Economics Papers: this item is included in nep-ban and nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (31)

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Journal Article: Endogenous intermediation in over-the-counter markets (2017)
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