Working Papers
December 2023, No. 23-13
Dealer Costs and Customer Choice
We introduce a model to explain how an increase in intermediation costs leads to structural changes in the corporate bond market. We state three facts on corporate bond markets after the Dodd-Frank act: (1) an increase in customer liquidity provision through prearranged matches, (2) a paradoxical decrease in measured illiquidity, and (3) an increase in the illiquidity component on the yield spread. Investors take longer to finish a trade and require higher illiquidity premium even though measured illiquidity decreased. We introduce a search and matching model which explains these facts. It also suggests the possibility of multiple equilibria and financial instability when dealers face high costs to intermediate transactions.
Contact Us
Katrina Mullen
(804) 697-8145