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Dark MarketsAsset Pricing and Information Transmission in Over-the-Counter Markets$
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Darrell Duffie

Print publication date: 2012

Print ISBN-13: 9780691138961

Published to Princeton Scholarship Online: October 2017

DOI: 10.23943/princeton/9780691138961.001.0001

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A Simple OTC Pricing Model

A Simple OTC Pricing Model

(p.42) Chapter 4 A Simple OTC Pricing Model
Dark Markets

Darrell Duffie

Princeton University Press

This chapter presents a simple introduction to asset pricing in over-the-counter markets. Investors search for opportunities to trade and bargain with counterparties, each counterparty being aware that failure to conduct a trade could lead to a costly new search for a counterparty. In equilibrium, whenever there is gain from trade, the opportunity to search for a new counterparty is dominated by trading at the equilibrium asset price. The asset price reflects the degree of search frictions. Under conditions, illiquidity premia are higher when counterparties are harder to find, when sellers have less bargaining power, when the fraction of qualified owners is smaller, and when risk aversion, volatility, or hedging demand is larger. Supply shocks cause prices to jump, and then “recover” over time, with a pattern that depends on the degree of search frictions. The chapter shows how the equilibrium bargaining powers of the counterparties are determined by search opportunities using the approach of Rubinstein and Wolinsky (1985).

Keywords:   asset pricing, trading, supply shocks, equilibrium bargaining, over-the-counter market, OTC market

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