Seminar

Trading and Information Diffusion in Over-the-Counter Markets

Peter Kondor (Central European University)

November 12, 2012, 12:30–14:00

Room MF 323

Paul Woolley Research Initiative Seminar

Abstract

This paper studies the informational efficiency of over-the-counter markets. We consider an over-the-counter market where dealers trade an asset with a stochastic payoff. Trade is bilateral, and each dealer can simultaneously participate in multiple transactions. The value of the asset is interdependent, and dealers are privately informed about it. Dealers learn additional information from the prices in the transactions they engage in. We show that although dealers trade strategically, the information that is revealed through trading is only distorted by the pattern of bilateral trades. Moreover, information diffuses through the network of trading links, such that the price in any bilateral transaction partially incorporates the private signals of all dealers in the market. In the common-value limit, over-the-counter markets are nearly as informationally efficient as centralized markets. Finally, our comparative static exercises illustrate the implications of these findings for intermediation and price dispersion in over-the-counter markets. Keywords: information aggregation; bilateral trading; demand schedule equilibrium