Endogenous Specialization and Dealer Networks

Batchimeg Sambalaibat, Artem Neklyudov, Artem Neklyudov - Aug 01, 2017

OTC markets exhibit a core-periphery network: 10-30 central dealers trade frequently and with many dealers, while hundreds of peripheral dealers trade sparsely and with few dealers. Existing work rationalize this phenomenon with exogenous dealer heterogeneity. We build a search-based model of network formation and propose that a core-periphery network arises from specialization. Dealers endogenously specialize in different clients with different liquidity needs. The clientele difference across dealers, in turn, generates dealer heterogeneity and the core-periphery network: The dealers specializing in clients who trade frequently form the core, while the dealers specializing in buy-and-hold investors form the periphery.
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network formation core-periphery directed search clientele effect specialization intermediation chains over-the-counter markets