Comparing search and intermediation frictions across markets

BIS Working Papers  |  No 1283  | 
08 August 2025
by Gabor Pinter, Semih Üslü and Jean-Charles Wijnandts
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Summary

Focus

Trading frictions are a defining feature of over-the-counter (OTC) financial markets, yet little is known about how they vary across asset classes or how they respond to periods of market stress. We develop a unified framework to measure and compare the sources of trading frictions in two key pillars of the financial system: the government and corporate bond markets. We also quantify the welfare costs of these frictions in normal and stressed environments.

Contribution

We build a structural model of OTC trading in which clients and dealers bargain over trade sizes and prices, and trading opportunities arrive with delays. The model incorporates multiple assets, various clients and inter-dealer bargaining frictions. The model can also identify the roles of search frictions – the time, energy and money that buyers and sellers expend to find one another – facing clients and of the market power of intermediaries. We estimate the model using a transaction-level data set that includes client identities and nearly all secondary market trades in UK gilts and sterling-denominated corporate bonds. By tracking the same clients across both markets, we can compare market structures while holding client composition constant.

Findings

We find that both trading delays and intermediation frictions are more severe in the corporate bond market than in the gilt market. Welfare losses due to these frictions are 2.4% in government bonds and 5.0% in corporate bonds – driven primarily by trading delays. During periods of stress such as the Covid-19 crisis, losses more than double, underscoring the fragility of the OTC market structure.

Abstract

We develop a two-asset search-and-bargaining model of OTC trading to estimate frictions and welfare losses in the UK government and corporate bond markets. Using transaction-level data and a matched client sample, we find that both trading delays and intermediation frictions are more pronounced in corporate bonds. Welfare losses due to these frictions are 2.4% in government bonds and 5.0% in corporate bonds-driven primarily by trading delays. Using data from the COVID-19 crisis, we find that these losses might more than double during turbulent times, revealing the fragility of the OTC market structure.

JEL classification: D40, G10, G11, L10

Keywords: search frictions, market power, government bonds, corporate bonds, over-the-counter markets

The views expressed in this publication are those of the authors and not necessarily those of the BIS.