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RFS Advance Access originally published online on June 30, 2006
Review of Financial Studies 2007 20(2):275-314; doi:10.1093/rfs/hhl012
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org.

Financial Intermediation and the Costs of Trading in an Opaque Market

Richard C. Green
Tepper School of Business, Carnegie Mellon University

Burton Hollifield
Tepper School of Business, Carnegie Mellon University

Norman Schürhoff
HEC—University of Lausanne and Swiss Finance Institute

Address correspondence to Burton Hollifield, Tepper School of Business, Carnegie Mellon University, Schenley Park, Pittsburgh, PA 15213-3890, or e-mail: burtonh{at}andrew.cmu.edu.


  Abstract

Municipal bonds trade in opaque, decentralized broker-dealer markets in which price information is costly to gather. We analyze a database of trades between broker-dealers and customers in municipal bonds. These data were only released to the public with a lag; the market was opaque. Dealers earn lower average markups on larger trades, even though dealers bear a higher risk of losses with larger trades. We estimate a bargaining model and compute measures of dealer’s bargaining power. Dealers exercise substantial market power. Our measures of market power decrease in trade size and increase in the complexity of the trade for the dealer. (JEL G0, G24)


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