Pricing and Liquidity in Decentralized Asset Markets

Uslu, Semih (2015): Pricing and Liquidity in Decentralized Asset Markets.

Abstract

I develop a search-and-bargaining model of endogenous intermediation in over-the-counter markets. Unlike the existing work, my model allows for rich investor heterogeneity in three simultaneous dimensions: preferences, inventories, and meeting rates. By comparing trading-volume patterns that arise in my model and are observed in practice, I argue that the heterogeneity in meeting rates is the main driver of intermediation patterns. I find that investors with higher meeting rates (i.e., fast investors) are less averse to holding inventories and more attracted to cash earnings, which makes the model corroborate a number of stylized facts that do not emerge from existing models: (i) fast investors provide intermediation by charging a speed premium, and (ii) fast investors hold more extreme inventories. Then, I use the model to study the effect of trading frictions on the supply and price of liquidity. On social welfare, I show that the interaction of meeting rate heterogeneity with optimal inventory management makes the equilibrium inefficient. In the equilibrium, investors have less dispersed inventories than the socially efficient allocation. I provide a financial transaction tax/subsidy scheme that corrects this inefficiency, in which fast investors cross-subsidize slow investors.

• Item Type: MPRA Paper
• Language: English
• Keywords: Search frictions; Bargaining; Price dispersion; Financial intermediation
• Subjects: D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D53 - Financial Markets; D - Microeconomics > D6 - Welfare Economics > D61 - Allocative Efficiency ; Cost-Benefit Analysis; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search ; Learning ; Information and Knowledge ; Communication ; Belief ; Unawareness; G - Financial Economics > G1 - General Financial Markets; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages

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