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(In)efficiency and Intervention in Over-The-Counter Markets

Author

Listed:
  • Nicholas Trachter

    (Federal Reserve Bank of Richmond)

  • Bruno Sultanum

    (Federal Reserve Bank of Richmond)

  • Zachary Bethune

    (University of Virginia)

Abstract

We augment Duffie et al.(2005), the workhorse model to study asset trade in over-the-counter markets, to allow for asset creation. We show that the equilibrium does not decentralize the efficient allocation. The result follows from the impossibility of having both buyers and sellers take into account the full social value of asset creation when trading. We show how this mis-pricing of assets affects asset issuance, and distorts trading, enhancing misallocation. The inefficiency of the economy provides a rational for financial regulation. We show that regulation can regain efficiency in the economy by a proper choice of a tax scheme, and that the level of intervention decreases with the degree of over-the-counter search frictions in the economy.

Suggested Citation

  • Nicholas Trachter & Bruno Sultanum & Zachary Bethune, 2017. "(In)efficiency and Intervention in Over-The-Counter Markets," 2017 Meeting Papers 1450, Society for Economic Dynamics.
    • Handle: RePEc:red:sed017:1450
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    References listed on IDEAS

    as
    1. Ricardo Lagos & Guillaume Rocheteau, 2009. "Liquidity in Asset Markets With Search Frictions," Econometrica, Econometric Society, vol. 77(2), pages 403-426, March.
    2. Lagos, Ricardo & Rocheteau, Guillaume & Weill, Pierre-Olivier, 2011. "Crises and liquidity in over-the-counter markets," Journal of Economic Theory, Elsevier, vol. 146(6), pages 2169-2205.
    3. Darrell Duffie & Nicolae Gârleanu & Lasse Heje Pedersen, 2007. "Valuation in Over-the-Counter Markets," The Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 1865-1900, November.
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