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Market-making with Search and Information Frictions / Benjamin Lester, Ali Shourideh, Venky Venkateswaran, Ariel Zetlin-Jones.
- Format:
- Book
- Author/Creator:
- Lester, Benjamin.
- Series:
- Working Paper Series (National Bureau of Economic Research) no. w24648.
- NBER working paper series no. w24648
- Language:
- English
- Physical Description:
- 1 online resource: illustrations (black and white);
- Place of Publication:
- Cambridge, Mass. National Bureau of Economic Research 2018.
- Summary:
- We develop a dynamic model of trading through market-makers that incorporates two canonical sources of illiquidity: trading (or search) frictions, which imply that market-makers have some amount of market power; and information frictions, which imply that market-makers face some degree of adverse selection. We use this model to study the effects of various technological innovations and regulatory initiatives that have reduced trading frictions in over-the-counter markets. Our main result is that reducing trading frictions can lead to less liquidity, as measured by bid-ask spreads. The key insight is that more frequent trading--or more competition among dealers--makes traders' behavior less dependent on asset quality. As a result, dealers learn about asset quality more slowly and set wider bid-ask spreads to compensate for this increase in uncertainty.
- Notes:
- Print version record
- May 2018.
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