Relationships, Inventories, and the Value of Private Information in a Decentralized Market
This paper is the first, to our knowledge, to study the value of private information, client-dealer relationships, and dealer inventories in a unified framework using granular transaction-level data. We use regulatory data with counterparty names as well as a wealth of other nonpublic information and implement a difference-in-difference strategy to assess the extent to which dealers may take advantage of the private information bestowed on them by clients during block trades, which are subject to delayed public dissemination. We find that on average, (i) dealers are not opportunistic with respect to the private information embedded in the block trades, (ii) having a relationship with a dealer does not necessarily help clients improve their prices, which is likely a reflection of the costs of immediacy, and (iii) higher inventories result in price deterioration for the dealers (i.e., lower selling prices and higher purchasing prices), ceteris paribus. We also find that dealers benefit from more favorable prices during times of market stress and increased volatility, that staleness of information does not have a significant impact, and that over time (quarter-to-quarter) it becomes increasingly more difficult for dealers to see price improvements relative to the prevailing market prices, likely due to advances in trading technology and increased sophistication of dealers’ counterparties.
