FINANCE


From Market Making to Matchmaking: Does Bank Regulation Harm Market Liquidity?


GIDEON SAAR PROFESSOR OF FINANCE


DR. PHILIP AND ROSALYN BARON PROFESSOR OF MANAGEMENT


Samuel Curtis Johnson Graduate School of Management


Cornell SC Johnson College of Business Cornell University


Te Review of Financial Studies, 36, 2, February 2023 LINK TO PAPER


Co-authors • Gideon Saar


Professor of Finance, Dr. Philip and Rosalyn Baron Professor of


Management, Samuel Curtis Johnson Graduate School of Management, Cornell SC Johnson College of Business, Cornell University


• Jian Sun, Lee Kong Chian School of Business, Singapore Management University • Ron Yang, Stanford University Graduate School of Business • Haoxiang Zhu, MIT Sloan School of Management and NBER


Summary Te aftermath of the financial crisis saw several regulatory initiatives designed


to curtail risk-taking by banks. In part, these initiatives reflected a widespread belief in banking regulatory circles that the precrisis price of immediacy did not adequately incorporate the costs required to ensure that market makers are supported by sufficient capital and do not become a source of illiquidity contagion. Some market observers have portrayed these regulatory initiatives as a trade-off: Reduced market liquidity during normal times in exchange for enhanced market resilience during stressful periods.


Te authors show that this can, somewhat surprisingly, improve overall investor welfare and reduce average transaction costs despite the increased cost of immediacy. Bank dealers in over-the-counter (OTC) markets optimize between two parallel trading mechanisms: market-making and matchmaking. Bank regulations that increase market-making costs change the market struc- ture by intensifying competitive pressure from nonbank dealers and incentiv- izing bank dealers to shift their business activities toward matchmaking. Tus, postcrisis bank regulations have the (unintended) benefit of replacing costly bank balance sheets with a more efficient form of financial intermediation.


TO IMPACT CONTENTS


RESEARCH WITH IMPACT: CORNELL SC JOHNSON COLLEGE OF BUSINESS • 2023 EDITION


35


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24  |  Page 25  |  Page 26  |  Page 27  |  Page 28  |  Page 29  |  Page 30  |  Page 31  |  Page 32  |  Page 33  |  Page 34  |  Page 35  |  Page 36  |  Page 37  |  Page 38  |  Page 39  |  Page 40  |  Page 41  |  Page 42  |  Page 43  |  Page 44  |  Page 45  |  Page 46  |  Page 47  |  Page 48  |  Page 49  |  Page 50  |  Page 51  |  Page 52  |  Page 53  |  Page 54  |  Page 55  |  Page 56  |  Page 57  |  Page 58  |  Page 59  |  Page 60  |  Page 61  |  Page 62  |  Page 63  |  Page 64  |  Page 65  |  Page 66  |  Page 67  |  Page 68  |  Page 69  |  Page 70  |  Page 71  |  Page 72  |  Page 73  |  Page 74  |  Page 75  |  Page 76  |  Page 77  |  Page 78  |  Page 79  |  Page 80  |  Page 81  |  Page 82  |  Page 83  |  Page 84  |  Page 85  |  Page 86  |  Page 87  |  Page 88  |  Page 89  |  Page 90  |  Page 91  |  Page 92  |  Page 93  |  Page 94  |  Page 95  |  Page 96  |  Page 97  |  Page 98  |  Page 99  |  Page 100  |  Page 101  |  Page 102  |  Page 103  |  Page 104  |  Page 105  |  Page 106  |  Page 107  |  Page 108  |  Page 109  |  Page 110  |  Page 111  |  Page 112  |  Page 113