Competing with Inventory in Dealership Markets

Existing literature on dealer liquidity provision and inventory management has focused on dealer inventory costs. I uncover a new inventory benefit channel: dealers strategically build inventory in order to compete for market share. I assess the relative impact of the inventory benefit and costs on the pricing of dealer liquidity provision and inventory management. Using the TRACE data for the U.S. corporate bonds, I show that, excluding the crisis, the inventory benefit per trade is on average 4.8 basis points larger than the inventory costs. The result is reversed during the crisis, when dealers suffer significantly higher inventory costs