Comparing Search and Intermediation Frictions Across Markets
Abstract
In intermediated markets, trading takes time and intermediaries extract rents. We estimatea structural search-and-bargaining model to quantify these trading delays, intermediaries’
ability to extract rents, and the resulting welfare losses in government and corporate bond
markets. Using transaction-level data from the UK, we identify a set of clients who are active
in both markets. We exploit the cross-market variation in the distributions of these clients’
trading frequency, prices, and trade sizes to estimate our structural model. We find that trading
delays and dealers’ market power both play a crucial role in explaining the differences in
liquidity across the two markets. Dealers’ market power is more severe in the government
bond market, while trading delays are more severe in the corporate bond market. We find
that the welfare loss from frictions in the government and corporate bond markets are 7.8%
and 12.2%, respectively, and our decomposition implies that this loss is almost exclusively
caused by trading delays in the corporate bond market, while trading delays and dealers’
market power split the welfare loss equally in the government bond market. Using data from
the COVID-19 crisis period, we also find that these welfare losses might more than triple
during turbulent times, revealing the fragility of the OTC market structure.