Pricing and Liquidity in Decentralized Asset Markets
123 Pages Posted: 22 Sep 2016 Last revised: 8 Feb 2019
Date Written: February 5, 2019
Abstract
I develop a search-and-bargaining model of endogenous intermediation in over-the-counter markets. Unlike the existing work, my model allows for rich investor heterogeneity in three simultaneous dimensions: preferences, inventories, and meeting rates. By comparing trading-volume patterns that arise in my model and are observed in practice, I argue that the heterogeneity in meeting rates is the main driver of intermediation patterns. I find that investors with higher meeting rates (i.e., fast investors) are less averse to holding inventories and more attracted to cash earnings, which makes the model corroborate a number of stylized facts that do not emerge from existing models: (i) fast investors provide intermediation by charging a speed premium, and (ii) fast investors hold more extreme inventories. Then, I use the model to study the effect of trading frictions on the supply and price of liquidity. On social welfare, I show that the interaction of meeting rate heterogeneity with optimal inventory management makes the equilibrium inefficient. I provide a financial transaction tax/subsidy scheme that corrects this inefficiency, in which fast investors cross-subsidize slow investors.
Keywords: Search frictions, Bargaining, Price dispersion, Financial intermediation
JEL Classification: G1, G11, G12, G21, D83, D53, D61
Suggested Citation: Suggested Citation