The Effect of Intermediaries’ Market Power in Decentralized Asset Markets

This paper shows that the presence of intermediaries’ market power in decentralized asset markets reduces volumes traded and increases price volatility. I develop a method to estimate the degree of intermediaries’ market power from trading data and I apply it to the US municipal bond market using a new dataset containing all trades executed in this market. I find a high degree of dealer market power in this market, which reduces volumes traded by 65% to 70%. I use the model to evaluate investors’ behavior under alternative policy interventions that could improve trading activity and the efficiency of the market. The introduction of weekly auctions where investors can trade directly with each other is the most effective, increasing volumes traded by roughly 60% and the allocation efficiency of the market by 80%. JEL: D53, D83, G12, G14, L10, L50