Dealer Intermediation in Models of OTC Asset Markets

Abstract

Duffie, Garleanu, and Pedersen (DGP) (2005) and Vayanos and Wang (2007) develop search-based models of over-the-counter (OTC) markets in which investors meet randomly and bargain bilaterally. However, neither model accounts for dealers who match buyers and sellers in real-world OTC markets. I modify the models of DGP and Vayanos and Wang by introducing dealers who extract a share of the gains from trade via the bid-ask spread, while holding matching processes and allocation fixed. I find that under this construction, dealers reduce investor welfare by the discounted value of spreads.