Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/246484 
Year of Publication: 
2020
Series/Report no.: 
Working Paper No. 2020-03
Publisher: 
Rutgers University, Department of Economics, New Brunswick, NJ
Abstract: 
A large number of financial assets are traded in both exchanges and over-the-counter markets (i.e., centralized and decentralized markets, CM and DM hereafter, respectively). Moreover, as documented by Biais and Green (2019), the 20th century has witnessed a secular migration of asset trade from CM to DM. To this end, this paper develops a tractable model on strategic selection of venue trading to study the causes and consequences of the endogenous coexistence of CM and DM. In the model, traders' choice of venue is shaped by the trade-off between information frictions in the CM and matching frictions in the DM. Closed-form solutions are obtained and used to characterize the endogenous share of trade across the two venues. We then use the model to evaluate two potential explanations of the migration from CM to DM: improvements in matching technologies and increases in the number of institutional investors. Surprisingly, while both forces could lead to more trade in DM, there exist parameter regions where the increase in the number of institutional investors leads to less trade in DM. We also obtain empirically testable implications that differentiate the two explanations.
Subjects: 
Exchange vs Over-The-Counter (OTC) Market
Adverse Selection
Search Frictions
Institutional Investors
Fragmented Financial Markets
JEL: 
D61
D82
D83
L10
Document Type: 
Working Paper

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