Trading and Information Di¤usion in Over-the-Counter Markets

We model trading and information di¤usion in OTC markets, when dealers with private information can engage in many bilateral transactions at the same time, they trade strate-gically, and dealersstrategies are represented as quantity-price schedules. We show that information di¤usion is e¤ective, but not informationally e ¢ cient. While each bilateral price partially aggregates the private information of all the dealers in one round of trading, prices can be more informative even within the constraints imposed by our environment. This is not a result of dealersmarket power, but arises from the interaction between de-centralization and di¤erences in dealersvaluation of the asset. Furthermore, dealers with more trading partners are ex post better informed, tend to trade and intermediate more, earn more pro\u85t per transaction, set smaller e¤ective spreads, and trade at less dispersed prices. We also revisit alternative explanations behind the disruption of OTC markets in the recent \u85nancial crisis