Search and Inventory in Over‐the‐Counter Markets

ABSTRACT We investigate the sources of the dealer centrality premium in the over‐the‐counter market for corporate bonds. We model dealer heterogeneity by allowing the dealer's status in the network to determine search effort and inventory costs when choosing to conduct riskless principal or principal trades. Structural estimates match the observed centrality premium across transaction types and trade count deciles. Counterfactual analyses reveal that measures that limit core dealer bargaining power vis‐a‐vis clients reduce roundtrip spreads. Removing core dealers' advantage in search relative to peripheral dealers has little effect on transaction costs.