Dealer Intermediation Between Markets
Journal of the European Economic Association, 2015, Vol. 13(5), 770-804
with Peter Dunne and Michael Moore
We develop a dynamic model of dealer intermediation between a monopolistic customer-dealer (B2C) market and a competitive interdealer (B2B) market. Dealers face inventory constraints and adverse selection. We characterize the optimal quote setting and inventory management behavior for both markets in closed form and reveal how price setting in one market segment influences quote behavior in the other. The framework features a unique stable equilibrium for bid and ask quotes in both market segments. We show under which conditions dealer intermediation improves welfare over a spot trading venue which clears synchronous customer demand only, and how increased customer sophistication can make market breakdown more likely at high levels of price volatility. Data from the European sovereign bond market is used to illustrate some of the empirical implications.
A complementary Technical Web Appendix is available for this paper.
Powerpoint slides of a seminar presentation can be downloaded here.