Market Structure and Market Design

Paper Session

Sunday, Jan. 8, 2017 1:00 PM – 3:00 PM

Sheraton Grand Chicago, Chicago Ballroom VIII
Hosted By: American Finance Association
  • Chair: Pierre-Olivier Weill, University of California-Los Angeles

Can Decentralized Markets be More Efficient?

Vincent Glode
,
University of Pennsylvania
Christian Opp
,
University of Pennsylvania

Abstract

Decentralized markets attract large amounts of trade volume, even though they exhibit frictions absent in centralized exchanges. We develop a model with asymmetric information and expertise acquisition where some traders try to exploit any market structure to inefficiently screen their counterparties. In this environment, frictions characteristic of decentralized markets, such as time-consuming search, can promote higher efficiency. First, screening behavior may be less aggressive when traders reach fewer counterparties. Second, for asset classes where information improves allocative efficiency, decentralized markets with predictable trading encounters may dominate by encouraging expertise acquisition. In contrast, when information causes adverse selection, centralized markets dominate.

Size Discovery

Darrell Duffie
,
Stanford University
Haoxiang Zhu
,
Massachusetts Institute of Technology

Abstract

Size discovery is the use of trade mechanisms by which large quantities of an asset can be exchanged at a price that does not respond to price pressure. Primary examples of size discovery include ``workup'' in Treasury markets and block-trading ``dark pools'' in equity markets. By freezing the execution price and giving up market-clearing, a size-discovery mechanism overcomes large investors' concerns over price impacts. Price-discovery mechanisms clear the market, but cause investors to internalize their price impacts, inducing costly delays in the reduction of position imbalances. We show that augmenting a price-discovery mechanism with a size-discovery mechanism improves allocative efficiency.

Endogenous Specialization and Dealer Networks

Artem Neklyudov
,
University of Lausanne and Swiss Finance Institute
Batchimeg Sambalaibat
,
Indiana University

Abstract

OTC markets exhibit a core-periphery network: 10-30 central dealers trade frequently and with many dealers, while hundreds of peripheral dealers trade sparsely and with few dealers. Existing work rationalize this phenomenon with exogenous dealer heterogeneity. We build a search-based model of network formation and propose that a core-periphery network arises from specialization. Dealers endogenously specialize in different clients with different liquidity needs. The clientele difference across dealers, in turn, generates dealer heterogeneity and the core-periphery network: The dealers specializing in clients who trade frequently form the core, while the dealers specializing in buy-and-hold investors form the periphery.

Centralized Trading, Transparency and Interest Rate Swap Market Liquidity: Evidence From the Implementation of the Dodd-Frank Act

Evangelos Benos
,
Bank of England
Richard Payne
,
City University London
Michalis Vasios
,
Bank of England

Abstract

We use transactional data from the USD and EUR segments of the plain vanilla interest rate swap market to assess the impact of the Dodd-Frank mandate that US persons must trade certain swap contracts on Swap Execution Facilities (SEFs). We find that, as a result of SEF trading, activity increases and liquidity improves across the swap market, with the improvement being largest for USD mandated contracts which are most affected by the mandate. The associated reduction in execution costs is economically significant. For example, execution costs in USD mandated contracts, where SEF penetration is highest, drop, for market end-users alone, by $3-$4 million daily relative to EUR mandated contracts and in total by about $7-$13 million daily. We also find that inter-dealer activity drops concurrently with the improvement in liquidity suggesting that execution costs may have fallen because dealer intermediation chains became shorter. Finally we document that, in the EUR segment of the market, swap dealers have migrated a large fraction of their inter-dealer volume to their non-US trading desks creating the impression of geographic fragmentation. Although this has not compromised liquidity, it may have prevented further liquidity gains in that market segment. Overall, our results suggest that the improvements in transparency brought about by the Dodd-Frank trading mandate have substantially improved interest rate swap market liquidity.
Discussant(s)
Briana Chang
,
University of Wisconsin-Madison
Marzena Rostek
,
University of Wisconsin-Madison
Benjamin Lester
,
Federal Reserve Bank of Philadelphia
Emil Siriwardane
,
Harvard Business School
JEL Classifications
  • G1 - Asset Markets and Pricing