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Review of Financial Studies Vol. 36 No. 2 2023

From Market Making to Matchmaking: Does Bank Regulation Harm Market Liquidity?

Gideon Saar1; Jian Sun2; Ron Yang3; Haoxiang Zhu4

1 Cornell University Johnson Graduate School of Management, SC Johnson College of Business, , USA · 2 Singapore Management University Lee Kong Chian School of Business, , Singapore · 3 Stanford University Graduate School of Business, , USA · 4 MIT Sloan School of Management and NBER , USA

Abstract

Postcrisis bank regulations raised market-making costs for bank-affiliated dealers. We show that this can, somewhat surprisingly, improve overall investor welfare and reduce average transaction costs despite the increased cost of immediacy. Bank dealers in OTC markets optimize between two parallel trading mechanisms: market making and matchmaking. Bank regulations that increase market-making costs change the market structure by intensifying competitive pressure from nonbank dealers and incentivizing bank dealers to shift their business activities toward matchmaking. Thus, postcrisis bank regulations have the (unintended) benefit of replacing costly bank balance sheets with a more efficient form of financial intermediation.

DOI
10.1093/rfs/hhac068
Volume
36
Issue
2
Pages
678-732
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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