Liquidity in Competitive Dealer Markets
We study a continuous-time version of the intermediation model of Grossman
and Miller (1988). To wit, we solve for the competitive equilibrium prices at
which liquidity takers' demands are absorbed by dealers with quadratic
inventory costs, who can in turn gradually transfer these positions to an
end-user market. This endogenously leads to a model with transient price
impact. Smooth, diffusive, and discrete trades all incur finite but nontrivial
liquidity costs, and can arise naturally from the liquidity takers'