nep-mst 2015-11-15 papers

on Market Microstructure

Issue of 2015‒11‒15
one paper chosen by
Thanos Verousis

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

Endogenous Market-making and Formation of Trading Links

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
URL:	http://d.repec.org/n?u=RePEc:red:sed015:1227&r=mst

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