Dealer Intermediation between Markets
46 Pages Posted: 4 Sep 2012
There are 2 versions of this paper
Dealer Intermediation between Markets
Dealer Intermediation between Markets
Date Written: August 30, 2012
Abstract
We develop a dynamic model of dealer intermediation between a monopolistic customerdealer (B2C) market and a competitive inter-dealer (B2B) market. Dealers face inventory constraints and adverse selection. We characterize the optimal quote setting and inventory management behavior for both markets in closed form and reveal how price setting in one market segment influences quote behavior in the other. The framework features a unique stable equilibrium for bid and ask quotes in both market segments. We show under which conditions dealer intermediation improves welfare over a spot trading venue which clears synchronous customer demand only, and how increased customer sophistication can make market breakdown more likely at high levels of price volatility. Data from the European sovereign bond market is used to illustrate some of the empirical implications.
Keywords: Dealer Intermediation, Spread Determination, Adverse Selection, Market Segmentation
JEL Classification: G24, G14
Suggested Citation: Suggested Citation