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Trading and Information Diffusion in Over‐the‐Counter Markets

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  • Ana Babus
  • Péter Kondor
Abstract
We propose a model of trade in over‐the‐counter (OTC) markets in which each dealer with private information can engage in bilateral transactions with other dealers, as determined by her links in a network. Each dealer's strategy is represented as a quantity‐price schedule. We analyze the effect of trade decentralization and adverse selection on information diffusion, expected profits, trading costs, and welfare. Information diffusion through prices is not affected by dealers' strategic trading motives, and there is an informational externality that constrains the informativeness of prices. Trade decentralization can both increase or decrease welfare. A dealer's trading cost is driven by both her own and her counterparties' centrality. Central dealers tend to learn more, trade more at lower costs, and earn higher expected profit.

Suggested Citation

  • Ana Babus & Péter Kondor, 2018. "Trading and Information Diffusion in Over‐the‐Counter Markets," Econometrica, Econometric Society, vol. 86(5), pages 1727-1769, September.
    • Handle: RePEc:wly:emetrp:v:86:y:2018:i:5:p:1727-1769
    DOI: 10.3982/ECTA12043
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    More about this item

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation

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