Seminar

Endogenous Intermediation in Over-the-Counter Markets

Ana Babus (Federal Reserve Bank of Chicago)

June 27, 2016, 12:30–14:00

Room MF 323

Paul Woolley Research Initiative Seminar

Abstract

We provide a theory of trading through intermediaries in OTC markets. The role of intermediaries is to sustain trade, when trade is beneficial. In our model, traders are connected through a network. Agents observe their neighbors’ actions, and can trade with their counterparty in a given period through a path of intermediaries in the network. However, agents can renege on their obligations. We show that trading through a network is essential to support trade, when agents infrequently meet the same counteparty in the market. However, intermediaries must receive fees to have the incentive to implement trades. Concentrated intermediation, as represented by a star network, is both a constrained efficient and a stable structure, when agents incur linking costs. Moreover, the center agent in a star can receive higher fees as well.