Agency Frictions, Dealer Funding, and Market Liquidity
|Speaker:||John C.F. Kuong, Insead|
|Date:||Tuesday 23 October 2018|
|Location:||Kolade Teaching Room|
A dealer serves its clients by using its capital to immediately absorb their demand and supply of assets and then close the positions later. We consider a model in which financially constrained dealers optimally raise capital to provide such service. We show that agency problem hinders dealers' funding, thus reduces capacity and increases cost of immediacy provision. This translates to the worsening of market liquidity of the asset: the bid-ask spread widens and the trading volume decreases. We also show that leverage ratio requirement on dealers will harm market liquidity further, consistent with evidence.