This extension delivers two insight

This extension delivers two insights. First, we show that unconnected (connected) deal-ers always charge a higher (lower) bid-ask spread than core dealers. Indeed, unconnecteddealers do not have access to the core market and trade at unfavorable prices in the pe-ripheral market if they are on the crowded side. Conversely, connected dealers can exploittheir bargaining power over unconnected dealers to obtain a better price in the peripheralmarket than in the core market and unload their inventories on core dealers if they donot find a counterparty among peripheral dealers. Thus, overall, connected dealers get ahigher payoff from acquiring inventory positions than other dealers. Moreover, numericalsimulations (Fig. 7) show that the difference in bid-ask spreads charged by connected andunconnected dealers increases when fewer dealers are connected to core dealers. Thus,dealers’ connectedness is a determinant of price dispersion both in the interdealer marketand for trades between dealers and their customers.Second, inefficiencies in the allocation of inventory costs among dealers (see the pre-vious section) lead to higher transaction costs for dealers’ clients relative to the first bestallocation of inventories among dealers. Moreover, these transaction costs increase withλ because inefficiencies in the interdealer market become more serious as more peripheraldealer lose access to core dealers. Figure 8 illustrates these points by showing transactioncosts for peripheral dealers’ clients in (i) equilibrium and (ii) the first best allocation givenin Proposition 4. For λ = 1/2, equilibrium transaction costs for clients are almost twiceas high as what is achievable under the first-best.