Finance and Economics Discussion Series (FEDS)
November 2014
Dealer Networks
Dan Li and Norman Schurhoff
Abstract:
Dealers in over-the-counter securities form networks to mitigate search frictions. The audit trail for municipal bonds shows the dealer network has a core-periphery structure. Central dealers are more efficient at matching buyers and sellers than peripheral dealers, which shortens intermediation chains and speeds up trading. Investors face a tradeoff between execution speed and cost. Central dealers provide immediacy by pre-arranging fewer trades and holding larger inventory. However, trading costs increase strongly with dealer centrality. Investors with strong liquidity need trade with central dealers and at times of market-wide illiquidity. Central dealers thus serve as liquidity providers of last resort.
Keywords: Municipal bonds, over-the-counter financial market, network analysis, trading cost, liquidity, immediacy, transparency
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