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Endogenous intermediation in over-the-counter markets

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  • Babus, Ana
  • Hu, Tai-Wei

Abstract

We provide a theory of trading through intermediaries in over-the-counter markets. The role of intermediaries is to sustain trade. In our model, traders are connected through an informational network. Agents observe their neighbors’ actions and can trade with their counterparty in a given period through a path of intermediaries in the network. Nevertheless, agents can renege on their obligations. We show that trading through an informational network is essential to support trade when agents infrequently meet the same counteparty. However, intermediaries must receive fees to implement trades. Concentrated intermediation, as represented by a star network, is both constrained efficient and stable when agents incur linking costs. The center agent in a star can receive higher fees as well.

Suggested Citation

  • Babus, Ana & Hu, Tai-Wei, 2017. "Endogenous intermediation in over-the-counter markets," Journal of Financial Economics, Elsevier, vol. 125(1), pages 200-215.
    • Handle: RePEc:eee:jfinec:v:125:y:2017:i:1:p:200-215
    DOI: 10.1016/j.jfineco.2017.04.009
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    References listed on IDEAS

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    More about this item

    Keywords

    Over-the-counter trading; Strategic default; Dynamic network formation;
    All these keywords.

    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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