Dealer Intermediation between Markets

46 Pages Posted: 4 Sep 2012

See all articles by Peter G. Dunne

Peter G. Dunne

Central Bank of Ireland

Harald Hau

University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Michael Moore

University of Warwick - Warwick Business School

Multiple version iconThere are 2 versions of this paper

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

Dunne, Peter G. and Hau, Harald and Moore, Michael John, Dealer Intermediation between Markets (August 30, 2012). Swiss Finance Institute Research Paper No. 12-29, WBS Finance Group Research Paper No. 192, Available at SSRN: https://ssrn.com/abstract=2140833 or http://dx.doi.org/10.2139/ssrn.2140833

Peter G. Dunne

Central Bank of Ireland ( email )

P.O. Box 559
Dame Street
Dublin, 2
Ireland

Harald Hau (Contact Author)

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland

Swiss Finance Institute

Switzerland

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Michael John Moore

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

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