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Dark Markets by Darrell Duffie

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CHAPTER 4

A Simple OTC Pricing Model

This chapter, based entirely on Duffie, Gârleanu, and Pedersen (2005, 2007),1 presents a simple introduction to asset pricing in OTC markets. Investors search for opportunities to trade and bargain with counterparties, each counterparty being aware that failure to conduct a trade could lead to a costly new search for a counterparty. In equilibrium, whenever there is gain from trade, the opportunity to search for a new counterparty is dominated by trading at the equilibrium asset price. The asset price reflects the degree of search frictions.

Under conditions, illiquidity premia are higher when counterparties are harder to find, when sellers have less bargaining power, when the fraction of qualified owners ...

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