Dealers' Search Intensity in U.S. Corporate Bond Markets

Abstract

Are dealers' search efforts endogenous in decentralized markets? How do dealers' search efforts affect market efficiency? We propose a model with dealers choosing idiosyncratic search intensities, and estimate the model using transaction data on U.S. corporate bonds. We find that:

[1] with dealers ranked by their private valuations for a bond, the middle-type dealer chooses the highest search intensity, and she reallocates bond positions from lower-type dealers to higher-type dealers;

[2] the estimated model predicts that the search costs and bond mis-allocation in current OTC markets generate 13.7% welfare loss relative to a counterfactual friction-less market.

Keywords: corporate bond market, endogenous search intensity, market inefficiency, search model estimation

JEL Classification: G10, G12, G21