nep-mst New Economics Papers
on Market Microstructure
Issue of 2015‒11‒15
one paper chosen by
Thanos Verousis

  1. Endogenous Market-making and Formation of Trading Links By Shengxing Zhang; Briana Chang

  1. By: Shengxing Zhang (London School of Economics); Briana Chang (University of Wisconsin Madison)
    Abstract: This paper develops a dynamic matching model to analyze the equilibrium trading structure in OTC markets. All traders have the same trading technology, and they optimally choose whom to connect to as well as whether to remain active in each period. We show that traders with more volatile preference (i.e. with higher needs for trade) always choose to match with traders with more stable preference (i.e., with less needs for trade) and they also leave the market earlier. The model therefore endogenously generates a core-periphery market structure, where traders with less trading needs develop more trading links in equilibrium and act like market makers. As the role of market-making is endogenous, we therefore provide an answer to why customers choose to trade with dealers instead of trading among themselves, and we can analyze how the market-making profit depends on underlying frictions.
    Date: 2015

This nep-mst issue is ©2015 by Thanos Verousis. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.