Opaqueness and Liquidity in Over-the-Counter Markets

Abstract We develop a model of search in OTC markets with asymmetric information and trade occurring under double-sided uncertainty over asset quality, where holding the asset does not necessarily translate into knowing its quality. This leads to deterioration of market information conditions over subsequent trades, causing both sellers and buyers to become more pessimistic even though aggregate asset quality remains unchanged. If re-trade opportunities are frequent, information in the economy becomes coarser, hindering market liquidity and volume of trade.

Keywords: over-the-counter, liquidity, learning by holding, opaqueness

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