Trading and Information Diffusion in Over-the-Counter Markets

Abstract

We model trading and information di¤usion in OTC markets, when dealers can engage in many bilateral transactions at the same time. We show that information di¤usion is e¤ective, but not e¢ cient. While each bilateral price partially reveals all dealers’ private information after a single round of trading, dealers could learn more even within the constraints imposed by our environment. This is not a result of dealers’ market power, but arises from the interaction between decentralization and di¤erences in dealers’valuation of the asset. We apply our framework to con- front several explanations for the disruption of OTC markets with stylized facts from the empirical literature. We …nd more support for narratives emphasizing increased counterparty risk as opposed to increased informational frictions.