Endogenous intermediation in over-the-counter markets

Ana Babus*, Tai Wei Hu

*Corresponding author for this work

Research output: Contribution to journalArticle (Academic Journal)

10 Citations (Scopus)
248 Downloads (Pure)

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.

Original languageEnglish
Pages (from-to)200-215
Number of pages16
JournalJournal of Financial Economics
Volume125
Issue number1
Early online date8 May 2017
DOIs
Publication statusPublished - 1 Jul 2017

Structured keywords

  • ECON Macroeconomics
  • ECON Microeconomic Theory

Keywords

  • Dynamic network formation
  • Over-the-counter trading
  • Strategic default

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