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Signaling in OTC Markets: Benefits and Costs of Transparency

Published online by Cambridge University Press:  16 October 2018

Kerry Back Open the ORCID record for Kerry Back [Opens in a new window] ,
Ruomeng Liu  and
Alberto Teguia
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Abstract

We provide a theoretical rationale for dealer objections to ex post transparency in over-the-counter markets. Disclosure of the terms of a transaction conveys information possessed by the dealer about the asset quality and reduces the dealer’s rents when she disposes of the inventory in a second transaction. We show that costly signaling in a transparent market benefits investors through lower spreads and higher volume. Dealers may also gain from transparency despite lower spreads when potential gains from trade are small or adverse selection is high, because in those circumstances higher volume offsets smaller spreads for dealer profits.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 1 , February 2020 , pp. 47 - 75
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

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Footnotes

1

This research was conducted while Liu and Teguia were students at Rice University and while Teguia was a post-doc at École Polytechnique Federale de Lausanne. We thank Shmuel Baruch, Alan Crane, Kevin Crotty, Semyon Malamud, and S. “Vish” Viswanathan (the referee) for very helpful comments.

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