Chaojun Wang is an assistant professor of finance at the Wharton School of the University of Pennsylvania.
His primary research interests are in over-the-counter financial markets, market structure and market design. His research has received the 2017 FTG first prize for Best Job Paper, the 2017 Marshall Blume Prize, the 2017 Cubist Ph.D. Candidate Award and the 2017 Young Scholars Finance Consortium award for Best Ph.D. Student Paper.
He earned his PhD from Stanford University.
Contrary to the prediction of the classic adverse selection theory, more informed traders could receive better pricing relative to less informed traders in over-the-counter financial markets. Dealers actively chase informed orders to better position their future quotes and avoid winner's curse in subsequent trades. On a multi-dealer platform, dealers' incentive of information chasing exactly offsets their fear of adverse selection. In a more general setting, information chasing can dominate adverse selection when dealers face differentially informed speculators, while adverse selection dominates when dealers face differentially informed trades from a given speculator. These two seemingly contrasting predictions are supported by empirical evidence from the UK government bond market.
We show that larger trades incur lower trading costs in government bond markets (“size discount”), but costs increase in trade size after controlling for clients’ identities (“size penalty”). The size discount is driven by the cross-client variation of larger traders obtaining better prices, consistent with theories of trading with imperfect competition. The size penalty, driven by within-client variation, is larger for corporate bonds and during major macroeconomic surprises as well as during COVID-19. These differences are larger among more sophisticated clients, consistent with theories of asymmetric information. We propose a trading model with bilateral bargaining and adverse selection to rationalize the co-existence of the size penalty and discount.
We show that trading over-the-counter is privately optimal yet can harm welfare even if its prices were competitive. Dealers price discriminate to the benefit of traders who are less likely to be informed, thereby cream-skimming them into the OTC market and leaving adverse selection risk concentrated on exchanges. Traders who are induced to trade by better OTC prices have smaller gains from trade than those who exit due to worse prices on the exchanges. Therefore, the entrants are mere “cheap substitutes” for the exiters, rendering trade volume and bid-ask spreads poor indicators of welfare. We also document and explain a positive correlation between the exchanges’ spread and their market share. Given this pattern, perhaps surprisingly, we show that allowing OTC trading harms welfare for assets that are mostly OTC-traded, such as swaps.
Core-periphery trading networks arise endogenously in over-the-counter markets as an equilibrium balance between trade competition and inventory efficiency. A small number of firms emerge as core dealers to intermediate trades among a large number of peripheral firms. The equilibrium number of dealers depends on two countervailing forces: (i) competition among dealers in their pricing of immediacy to peripheral firms, and (ii) the benefit of concentrated intermediation in balancing dealer inventory through dealers’ ability to quickly net purchases against sales. For an asset with a lower frequency of trade demand, intermediation is concentrated among fewer dealers, and interdealer trades account for a greater fraction of total trade volume. These two predictions are strongly supported by evidence from the Bund and U.S. corporate bond markets. From a welfare viewpoint, I show that there are too few dealers for assets with frequent trade demands, and too many for assets with infrequent trade demands.
We model bargaining in over-the-counter network markets over the terms and prices of contracts. Of concern is whether bilateral non-cooperative bargaining is sufficient to achieve efficiency in this multilateral setting. For example, will market participants assign insolvency-based seniority in a socially efficient manner, or should bankruptcy laws override contractual terms with an automatic stay? We provide conditions under which bilateral bargaining over contingent contracts is efficient for a network of market participants. Examples include seniority assignment, close-out netting and collateral rights, secured debt liens, and leverage-based covenants. Given the ability to use covenants and other contingent contract terms, central market participants efficiently internalize the costs and benefits of their counterparties through the pricing of contracts. We provide counterexamples to efficiency for less contingent forms of bargaining coordination.