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

  • 2019.03.21
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Speaker: Prof. Haoxiang Zhu (Massachusetts Institute of Technology)

Topic:

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

 

Time&Date: 

  12:00-13:15 pm, 2019/3/29 (Friday)

Venue:

  Room 619, Teaching A

Speaker:

Prof. Haoxiang Zhu (Massachusetts Institute of Technology)
Abstract: Post-crisis bank regulations, such as Basel III and the Volcker Rule, raised the market making costs of bank-affiliated dealers. We show that the increase in banks dealers’ balance sheet costs can, somewhat surprisingly, reduce customers’ average transaction costs and increase their overall welfare. In the model, bank dealers both provide market making services to customers and invest in a search technology that matches buyers and sellers (matchmaking). If balance sheet costs are low, bank dealers underinvest in the matchmaking technology to preserve market making profits, even when customers are better off trading directly with each other via search. An increase in balance sheet costs incentivizes bank dealers to invest in the technology and shift their business towards matchmaking, especially if they face competitive pressure from non-bank dealers that are not subject to bank regulations. As a result, this shift to matchmaking reduces customers’ average transaction costs and increases their overall welfare. Predictions from our model are supported by recent evidence in US corporate bond markets. Overall, our results show that post-crisis bank regulation has the unintended benefit of replacing costly balance sheet of banks by more efficient technology in financial intermediation.