Financial Intermediation Chains in an OTC Market

Ji Shen, Bin Wei, and Hongjun Yan
Working Paper 2018-15
December 2018

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This paper analyzes financial intermediation chains in a search model with an endogenous intermediary sector. We show that the chain length and price dispersion among interdealer trades are decreasing in search cost, search speed, and market size but increasing in investors' trading needs. Using data from the U.S. corporate bond market, we find evidence broadly consistent with these predictions. Moreover, as search speed approaches infinity, the search equilibrium does not always converge to the centralized-market equilibrium: prices and allocation converge, but the trading volume might not. Finally, we analyze the multiplicity and stability of the equilibrium.

JEL classification: G10

Key words: search, chain, financial intermediation, multiplicity, stability

The authors thank Bruno Biais, Briana Chang, Marco Di Maggio, Darrell Duffie, Nicolae Garleanu, Pete Kyle, Ricardo Lagos, Lin Peng, Matt Spiegel, Dimitri Vayanos, S. Viswanathan, Pierre-Olivier Weill, and Randall Wright. They also thank seminar participants at BI Norwegian Business School; Frankfurt School of Finance and Management; the University of California, Los Angeles; the University of Mannheim; Yale University; the eighth annual conference of The Paul Woolley Centre for the Study of Capital Market Dysfunctionality; the eleventh World Congress of the Econometric Society; the 2015 Summer Workshop on Money, Banking, Payments and Finance; and the Summer Institute of Finance Meeting for helpful comments. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility. The latest version of the paper is available at
Please address questions regarding content to Ji Shen, Department of Finance, Peking University, Beijing 100871, China; Bin Wei, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, 404-498-8913,; or Hongjun Yan, Department of Finance, DePaul University, 1 E. Jackson Blvd., Suite 5300, Chicago, IL 60604,
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