Bid-ask spreads and the over-the-counter interdealer markets: Core and peripheral dealers

This paper studies heterogeneity in search technology among dealers in an over-the-counter (OTC) market. Empirical evidence suggests that in many OTC markets dealer networks have a core-peripheral structure with customer bid-ask spreads depending on whether a customer trades with a more central dealer or a more peripheral dealer. The paper develops a baseline search and matching model, which produces a robust centrality discount—lower bid-ask spreads offered by more central dealers. When dealers are allowed to move sufficient amounts of trading capital between their idiosyncratic states the same model parameters may produce a centrality premium. Numerical analysis of the model shows the effects of different underlying distributions of the heterogeneity in search technology on dealer networks and welfare.