Liquidity in Competitive Dealer Markets
Trading and Market Microstructure
2021-03-03 v3 General Finance
Portfolio Management
Abstract
We study a continuous-time version of the intermediation model of Grossman and Miller (1988). To wit, we solve for the competitive equilibrium prices at which liquidity takers' demands are absorbed by dealers with quadratic inventory costs, who can in turn gradually transfer these positions to an exogenous open market with finite liquidity. This endogenously leads to transient price impact in the dealer market. Smooth, diffusive, and discrete trades all incur finite but nontrivial liquidity costs, and can arise naturally from the liquidity takers' optimization.
Keywords
Cite
@article{arxiv.1807.08278,
title = {Liquidity in Competitive Dealer Markets},
author = {Peter Bank and Ibrahim Ekren and Johannes Muhle-Karbe},
journal= {arXiv preprint arXiv:1807.08278},
year = {2021}
}
Comments
29 pages, 3 figures, forthcoming in 'Mathematical Finance'