Benchmarks in Search Markets

We analyze the role of benchmarks in over-the-counter markets subject to search frictions. The publication of a benchmark can, under conditions, raise total social surplus by (i) increasing the volume of beneficial trade, (ii) reducing total search costs, and (iii) facilitating more efficient trade matching between dealers and customers. Although the improvement in market transparency caused by benchmarks may lower dealer profit margins on each trade, dealers may nevertheless introduce a benchmark such as LIBOR in order to encourage greater market participation by investors. In some cases, the lowest-cost dealers may introduce a benchmark in order to increase their market share through reducing entry by high-cost dealers, a further source of efficiency gain.