More than half of the world's financial markets use a limit order book
mechanism to facilitate trade. For markets where trade is conducted
through a central counterparty, trading platforms disseminate the same
information about the limit order book to all market participants in
real time, and all market participants are able to trade with all
others. By contrast, in markets that operate under bilateral trade
agreements, market participants are only able to view the limit order
book activity from their bilateral trading partners, and are unable to
trade with the market participants with whom they do not possess a
bilateral trade agreement. In this talk, I discuss the implications
of such a market structure for price formation. I then introduce a
simple model of such a market, which is able to reproduce several
important empirical properties of traded price series. By identifying and
matching several robust moment conditions to the empirical data, I make
model-based inference about the network of bilateral trade partnerships
in the market. I discuss the implications of these findings for market
stability and suggest how the regulator might improve market conditions
by implementing simple restrictions on how market participants form their
bilateral trade agreements.