Information provision in over-the-counter markets

This paper analyzes endogenous information provision and purchase in over-the-counter (OTC) markets. On the supply side the optimal strategy of an information provider consists of selling identical information to all OTC traders. On the demand side OTC traders have an incentive to buy information from the same provider. If the incumbent information provider charges not too high a price, then an entrant firm has no demand even though it offers less expensive information of the same quality. This paper provides a rationale for the high level of market power in the industry for financial market data and credit rating services as well as why institutional traders may have no demand for a finer rating system. In addition, this paper shows that it is welfare improving for the security issuer to pay for rating services rather than having OTC traders purchase costly rating reports.

► We analyze the provision and purchase of financial information in over-the-counter markets.
► An information provider prefers to sell identical information to traders and traders prefer to coordinate on the same provider.
► We provide a rationale for the market power in this industry and why there may be no demand for a finer rating system.