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Endogenous liquidity risk and dealer market structure

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  • Jarrow, Robert
  • Li, Siguang

Abstract

This paper derives a liquidity cost process in a non-cooperative cost competition game among market makers and discusses its implication for the structure of a dealer market. The main result shows that there does not exist an equilibrium supporting both multiple market makers earning strictly positive profits and a well-behaved liquidity cost process (i.e. strictly increasing and convex) as documented in the price impact literature. Bertrand price competition arises as an equilibrium phenomenon, which naturally leads to the dominance of a cost-efficient market maker in the dealer market.

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  • Jarrow, Robert & Li, Siguang, 2021. "Endogenous liquidity risk and dealer market structure," The Quarterly Review of Economics and Finance, Elsevier, vol. 81(C), pages 449-453.
    • Handle: RePEc:eee:quaeco:v:81:y:2021:i:c:p:449-453
    DOI: 10.1016/j.qref.2020.10.025
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    References listed on IDEAS

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    Cited by:

    1. Jarrow, Robert & Lamichhane, Sujan, 2022. "Risk premia, asset price bubbles, and monetary policy," Journal of Financial Stability, Elsevier, vol. 60(C).

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    More about this item

    Keywords

    Endogenous liquidity risk; Bertrand price competition; Dealer market; Supply curve;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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