Asset Reallocation in Markets with Intermediaries Under Selling Pressure

Abstract

We study a search model of investors’ asset trading, intermediated by financial institutions that are at risk of selling under pressure. The pressure can lead to the development of a secondary market, where intermediaries bail each other out. Counterintuitively, an increase in competing intermediaries can lead to an increase of each intermediary’s value: the enhanced benefits of secondary trades can be so large as to dominate the reduction in value from narrower buy-sell spreads due to more intense competition. The market exhibits search externality; suppressing investors’ direct trading can improve welfare. We provide a calibration to the corporate acquisition market.

Keywords: Asset trading, OTC markets, Financial intermediation, Search and matching, Secondary market