Endogenous Market Making and Network Formation
58 Pages Posted: 29 Apr 2015 Last revised: 3 Aug 2021
Date Written: July 30, 2021
We propose a dynamic model of the over-the-counter market that jointly determines traders' connections with prices and asset flows. In an environment where ex ante homogeneous traders face uncertainty of other’s trading needs, a multilayered hierarchical market structure emerges to allow traders to better target their counterparties over time. Traders at a higher tier are committed to providing immediacy to those at a lower tier and become more central. Not only does the model rationalize the highly concentrated market and lengthy intermediation chains, it also generates new predictions for dealer centrality and markups that are consistent with the micro-level data.
Keywords: Trading Network, Over-the-Counter Market, Intermediation
JEL Classification: C70, G1, G20
Suggested Citation: Suggested Citation