Abstract - Dealer Networks: Market Quality in Over-The-Counter Markets

The MSRB Transaction Reporting System audit trail allows studying dealer intermediation and liquidity provision in decentralized over-the-counter markets. We find the dealership network in municipal bonds exhibits a hierarchical core-periphery structure with about 20-30 highly interconnected
dealers at its core and several hundred peripheral dealer firms. Market quality varies significantly across dealers depending on their interconnectedness and centrality within the trading network. Central dealers charge larger trading costs to investors and face lower loss probabilities than peripheral dealers. Yet, investor orders  flow through central dealers. Central dealers place
bonds more readily with investors than other dealers, consistent with smaller search frictions. Central dealers also provide more liquidity immediacy than peripheral dealers, leading central dealers to hold larger and more volatile inventories, keep bonds longer, and intermediate fewer pre-arranged
trades. Investors trade with central dealers when liquidity is otherwise low. Central dealers can thus be considered liquidity providers of last resort.

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