Why Trade Over-the-Counter?
60 Pages Posted: 13 Dec 2017 Last revised: 16 Nov 2022
There are 2 versions of this paper
Why Trade Over-the-Counter?
Why Trade Over-the-Counter? When Investors Want Price Discrimination
Date Written: February 5, 2018
Abstract
Over-the-counter trading thrives despite opposing regulatory pressure. In our model, traders who pose a lower adverse selection risk optimally choose the OTC market, where a dealer can offer a trader-specific discount. Closing the OTC market forces some traders to exit but induces others with larger gains from trade to enter. Overall, trade volume falls, average bid-ask spread widens, and yet welfare rises if the asset is mostly OTC-traded. An easy-to-implement Pigouvian tax strictly improves welfare over closing the OTC market. We predict that the exchange's spread is wider than the OTC spread and positively correlated with its market share.
Keywords: Over-the-counter, exchanges, adverse selection, price discrimination, venue choice, name give-up, permissioned blockchain
JEL Classification: D47, D61, D82, G14, G18
Suggested Citation: Suggested Citation