Skip to main content
About HEC About HEC Faculty & Research Faculty & Research Master’s programs Master’s programs MBA Programs MBA Programs PhD Program PhD Program Executive Education Executive Education Summer School Summer School HEC Online HEC Online About HEC Overview Overview Who
We Are Who
We Are
Egalité des chances Egalité des chances HEC Talents HEC Talents International International Campus
Life Campus
Life
Sustainability Sustainability Diversity
& Inclusion Diversity
& Inclusion
Stories Stories The HEC
Foundation The HEC
Foundation
Coronavirus Coronavirus
Faculty & Research Overview Overview Faculty Directory Faculty Directory Departments Departments Centers Centers Chairs Chairs Knowledge@HEC Knowledge@HEC Master’s programs Master in
Management Master in
Management
Master's
Programs Master's
Programs
Double Degree
Programs Double Degree
Programs
Summer
Programs Summer
Programs
Exchange
students Exchange
students
Student
Life Student
Life
Our
Difference Our
Difference
MBA Programs MBA MBA Executive MBA Executive MBA TRIUM EMBA TRIUM EMBA PhD Program Overview Overview HEC Difference HEC Difference Program details Program details Research areas Research areas HEC Community HEC Community Placement Placement Job Market Job Market Admissions Admissions Financing Financing Executive Education Executive Masters Executive Masters Executive Certificates Executive Certificates Executive short programs Executive short programs Online Online Companies Companies Executive MBA Executive MBA Infinity Pass Infinity Pass Summer School Youth Programs Youth Programs Summer programs Summer programs HEC Online Overview Overview Degree Program Degree Program Executive certificates Executive certificates MOOCs MOOCs Summer Programs Summer Programs Youth programs Youth programs
Faculty & Research

Research by Jean-Edouard Colliard and Thierry Foucault Published in the Journal of Finance

The Journal of Finance, one of the top journals in financial economics, just published the paper “Inventory Management, Dealers' Connections, and Prices in Over-the-Counter Markets” by HEC Paris finance professors Jean-Edouard Colliard and Thierry Foucault (together with Peter Hoffmann of the ECB).

 

Colliard Foucault Hoffmann

Many important financial assets (e.g., bonds, derivatives, currencies) trade in decentralized markets, often referred to as “over‐the‐counter” (OTC) markets. In these markets, dealers play a key role because they intermediate trades between end‐investors. To do so, they accumulate substantial inventory positions. These positions are costly to hold and are well‐known to have a significant bearing on market liquidity. To minimize their inventory costs, dealers trade among each other in the inter‐dealer market. However, dealers in OTC markets are typically heterogeneous. While some are well‐ connected, others have only few trading connections, and thus may find it more difficult to adjust their portfolio in the desired direction. 

The paper by Jean-Edouard Colliard, Thierry Foucault and Peter Hoffmann proposes a model of trading that studies the joint effects of dealers’ connectedness and inventory costs on prices and allocations. Consistent with stylized facts, we assume a two‐tiered structure with “core” and “peripheral” dealers. While trade is frictionless in the core, peripheral dealers bargain over the price with a limited set of other peripheral dealers. Importantly, only some of them are “connected” and can trade with core dealers. 

Given the structure of the model, there are two sources of market power among peripheral dealers. First, connected dealers have the option to resort to trading in the core, which improves their bargaining position relative to unconnected dealers. Second, a dealer’s inventory position relative to that of his/her competitors matters. In a market that is mainly populated by buyers, a seller will find it easy to get his/her trade done. In contrast, a buyer will have a hard time finding a seller and may thus not be able to trade. Importantly, we show that there is price dispersion in the periphery (a sign of some traders exerting market power over others) if, and only if, both frictions are present, i.e., if some dealers are unconnected and, at the same time, if there is an aggregate imbalance between buyers and sellers. “Our model makes precise predictions concerning how empirical researchers can measure the value of connectedness in OTC markets, a topic that has deserved considerable attention in the literature”, explain the researchers.