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Signaling in OTC Markets: Benefits and Costs of Transparency

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  • Back, Kerry
  • Liu, Ruomeng
  • Teguia, Alberto

Abstract

We provide a theoretical rationale for dealer objections to ex post transparency in over-the-counter markets. Disclosure of the terms of a transaction conveys information possessed by the dealer about the asset quality and reduces the dealer’s rents when she disposes of the inventory in a second transaction. We show that costly signaling in a transparent market benefits investors through lower spreads and higher volume. Dealers may also gain from transparency despite lower spreads when potential gains from trade are small or adverse selection is high, because in those circumstances higher volume offsets smaller spreads for dealer profits.

Suggested Citation

  • Back, Kerry & Liu, Ruomeng & Teguia, Alberto, 2020. "Signaling in OTC Markets: Benefits and Costs of Transparency," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 55(1), pages 47-75, February.
    • Handle: RePEc:cup:jfinqa:v:55:y:2020:i:1:p:47-75_2
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    Cited by:

    1. Cereda, Fábio & Chague, Fernando & De-Losso, Rodrigo & Genaro, Alan & Giovannetti, Bruno, 2022. "Price transparency in OTC equity lending markets: Evidence from a loan fee benchmark," Journal of Financial Economics, Elsevier, vol. 143(1), pages 569-592.
    2. Jean-Edouard Colliard & Gabrielle Demange, 2021. "Asset Dissemination Through Dealer Markets," Management Science, INFORMS, vol. 67(10), pages 6211-6234, October.
    3. James Brugler & Carole Comerton-Forde & J Spencer Martin, 2022. "Secondary Market Transparency and Corporate Bond Issuing Costs [Asset pricing and the bid–ask spread]," Review of Finance, European Finance Association, vol. 26(1), pages 43-77.
    4. Piotr Dworczak, 2020. "Mechanism Design With Aftermarkets: Cutoff Mechanisms," Econometrica, Econometric Society, vol. 88(6), pages 2629-2661, November.

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