Search and Inventory in the Over-the-Counter Market

More central dealers earn a premium over peripheral dealers in many types of markets. Possible explanations involve bargaining power, compensation for supplying liquidity, and faster execution speed. We investigate the sources of this premium in the over-the-counter market for corporate bonds. We construct a model of heterogeneous dealers and bonds in which a dealer's status in the network affects how it trades off search effort and inventory costs. Structural estimates show that core dealers exert more search effort per trade, hold out for higher-value clients, and earn higher roundtrip spreads than peripheral dealers for the same bond. Our theoretical findings allow us to quantitatively identify bonds that are either guaranteed to sell intraday or not. Overall, core dealers earn a centrality premium because (i) they search harder for guaranteed intraday trades, and (ii) they can afford to trade slower (not faster) than peripheral dealers for non-guaranteed intraday trades