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Manchester Grand Hyatt, Seaport G
American Finance Association
Intermediary Trading, Trading Venues, and Market Liquidity
Saturday, Jan. 4, 2020 2:30 PM - 4:30 PM (PDT)
- Chair: Yajun Wang, City University of New York-Baruch College
From Market Making to Matchmaking: Does Banking Regulation Harm Market Liquidity?
AbstractPost-crisis bank regulations raised the market-making costs of bank-affiliated dealers. We show that this can, somewhat surprisingly, improve the overall welfare of investors and reduce average transaction costs, despite the increased cost of immediacy. Bank dealers in OTC markets optimize between two parallel trading mechanisms: market making and matchmaking. Bank regulations that increase market-making costs intensify competitive pressure from non-bank dealers and incentivize bank dealers to invest in technology that shifts their business toward matchmaking. Thus, post-crisis bank regulations have the (unintended) benefit of replacing the costly balance sheet of banks with a more efficient form of financial intermediation.
Why Trade Over-the-Counter? When Investors Want Price Discrimination
AbstractDespite the availability of low-cost exchanges, over-the-counter (OTC) trading is pervasive for most assets. We explain the prevalence of OTC trading using a model of adverse selection, in which informed and uninformed investors choose to trade over-the-counter or on an exchange. OTC dealers' ability to price discriminate allows them to imperfectly cream-skim the uninformed investors from the exchange. Assets with wider bid-ask spreads on exchanges are predicted to have a higher proportion of total volume that is traded on exchanges, as supported by evidence from US stocks. Having an OTC market can reduce welfare while increasing total trade volume and decreasing average bid-ask spread. Specifically, for assets that are mostly traded over-the-counter (such as swaps and bonds), having the OTC market actually harms welfare. Our results justify recent policies that seek to end OTC trading for such assets.
University of Maryland
New York University
- G1 - General Financial Markets