For many assets, traders favor either over-the-counter (OTC) or centralized markets. This paper examines how traders’ choice between these trading venues depends on asset and trader characteristics. Traders have private information with heterogeneous precision and their values depend on a common and idiosyncratic component. A trader’s incentive to choose an OTC market depends on the benefit of learning the asset value and the potential cost due to price impact. Traders choose OTC markets over centralized exchanges when the idiosyncratic component dominates in asset values or their private information is sufficiently inaccurate, and thus, the benefit from learning is high. Market structures are endogenously determined by traders’ individual market choices. This paper provides comparative statics of endogenous market structures. When traders are asymmetric, the OTC and centralized markets can coexist. Furthermore, the OTC market decreases information efficiency by being conducive to trade only between informed traders.

Keywords: Noncompetitive trading, Over-the-counter markets, Exchanges, Price impact, Liquidity, Efficiency