Free-Riding and Herding in OTC Markets

Maria Betto and Matthew W. Thomas


Corporate bonds are traded in decentralized over-the-counter (OTC) markets which provide slower dissemination of information than equity markets. This causes players to “herd”, i.e., copy the purchase and sale actions of other players. We build a stylized model of a market leader and follower to explain two empirical facts: herding is more prevalent in (1) more liquid markets and (2) in sales than in buys. In our model, herding is more prevalent in liquid markets because the leader changes the market price less when taking action. Because this change is always detrimental for the follower, increased liquidity reduces the cost of waiting for the leader’s action. Herding is more prevalent in sales than buys because it is difficult to short sell in OTC markets. Therefore, any player who sells bought the asset in a previous period. When the leader buys, it reveals that it received a buy signal over a certain threshold. When the leader sells, it demonstrates both that the leader received a strong sell signal and that the original buy signal was not that strong.

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    title     = "Free-Riding and Herding in OTC Markets",
    author    = "Maria Betto and Matthew W. Thomas",
    journal   = "Working Paper",
    year      = "2022"