Surreal illustration of a broker controlling liquidity in OTC markets.

Is Your Broker Hiding Something? Uncover the Hidden Costs of Over-the-Counter Markets

Lena Voss in Business & Economy August 2025 • 4 min read.

"Liquidity misallocation in OTC markets can impact your investments. Learn how to navigate hidden fees and delays in over-the-counter trading for smarter financial decisions."

In the world of finance, over-the-counter (OTC) markets operate behind the scenes, facilitating the trade of assets that aren't listed on traditional exchanges. While these markets offer flexibility and access to a wide range of instruments, they're also known for their complexities and potential pitfalls. Ever experienced unexpected delays or higher costs when trading OTC? This is often due to liquidity misallocation, a situation where market inefficiencies distort asset prices and trading efficiency.

A new study sheds light on these hidden dynamics, revealing how dealers in OTC markets strategically manage liquidity to maximize their profits. By understanding these strategies, traders and investors can make more informed decisions and navigate the OTC landscape with greater confidence. This article will explore the core findings of this research, translating complex economic models into practical insights for everyday investors.

We will break down the key concepts, from dealer screening behaviors to the impact of market opacity, providing you with the knowledge to recognize and potentially mitigate the risks associated with OTC trading. Whether you're a seasoned investor or just starting out, understanding the nuances of liquidity in these markets is crucial for protecting your investments and achieving your financial goals.

Decoding Liquidity Misallocation: How OTC Markets Really Work

Surreal illustration of a broker controlling liquidity in OTC markets.

The central issue in OTC markets is that dealers and traders often have long-term relationships, yet the dealers don't always know the true value that traders place on the assets being traded. This information gap leads dealers to employ screening mechanisms, where they adjust trading speed and prices based on their assessment of a trader's potential profit. This strategic behavior, while profitable for the dealer, can create distortions in the market.

Imagine a scenario where a dealer has several clients: some eager to trade quickly for a high premium, others willing to wait for a lower price. The dealer, aiming to maximize profit, might prioritize high-urgency clients while delaying or even denying trades for those less willing to pay a premium. This is the essence of liquidity misallocation, where access to the market isn't equal, and the timing and cost of trades are influenced by factors beyond pure market forces.

Trade Breakdown: Trades with a small surplus don't happen at all.
Delayed Trades: Trades with intermediate surplus are slow.
High-Cost Trades: Trades with high surplus have big bid/ask spreads but happen quickly.

Several factors exacerbate these distortions. When valuations change rapidly, or when it's difficult for traders to form new relationships with dealers, the inefficiencies become more pronounced. Market opacity—the lack of transparency in pricing and trading activity—also plays a significant role, as it allows dealers to maintain informational advantages and further fine-tune their screening strategies. This leads to greater delays in trade and bigger differences between buying and selling prices for all involved.

Taking Control: Strategies for Navigating OTC Markets

While the complexities of OTC markets might seem daunting, understanding the underlying dynamics can empower you to make smarter investment decisions. By recognizing the potential for liquidity misallocation and the impact of dealer strategies, you can proactively manage your risk and seek opportunities for more efficient trading. Stay informed, diversify your strategies, and consider seeking expert advice to navigate the OTC landscape with greater confidence and achieve your financial goals.

About this Article -

This article was crafted using a human-AI hybrid and collaborative approach. AI assisted our team with initial drafting, research insights, identifying key questions, and image generation. Our human editors guided topic selection, defined the angle, structured the content, ensured factual accuracy and relevance, refined the tone, and conducted thorough editing to deliver helpful, high-quality information.See our About page for more information.

This article is based on research published under:

DOI-LINK: 10.2139/ssrn.2710221, Alternate LINK

Title: Liquidity Misallocation In An Over-The-Counter Market

Journal: SSRN Electronic Journal

Publisher: Elsevier BV

Authors: Shengxing Zhang

Published: 2016-01-01

Everything You Need To Know

What is liquidity misallocation in the context of Over-the-Counter (OTC) markets, and how does it affect my investments?

Liquidity misallocation in Over-the-Counter (OTC) markets occurs when market inefficiencies distort asset prices and trading efficiency. This happens because dealers, who facilitate trades in OTC markets, might prioritize certain clients or trades based on their assessment of potential profits, rather than pure market forces. For example, if a dealer believes a trader is willing to pay a high premium, they might offer quicker execution with a wider bid/ask spread. This can lead to unexpected delays, higher costs, and potentially unfavorable prices for investors, ultimately impacting their investment returns and financial goals.

How do dealers in Over-the-Counter (OTC) markets use screening mechanisms, and what impact does this have on traders?

Dealers in Over-the-Counter (OTC) markets use screening mechanisms to manage liquidity and maximize their profits, often because they lack complete information on the true value traders place on assets. These mechanisms involve adjusting trading speed and prices based on their evaluation of a trader's potential profit. This strategic behavior can create market distortions, leading to the following outcomes: trades with a small surplus might not happen at all, trades with an intermediate surplus can be slow, and trades with a high surplus may experience quick execution but with large bid/ask spreads. This can result in delays, higher costs, and uneven access to the market, impacting a trader's ability to execute trades efficiently and at favorable prices.

What is market opacity, and how does it contribute to the challenges in Over-the-Counter (OTC) trading?

Market opacity refers to the lack of transparency in pricing and trading activity within Over-the-Counter (OTC) markets. This lack of transparency gives dealers an informational advantage, allowing them to refine their screening strategies. The absence of clear pricing and trading data makes it harder for traders to assess fair prices, compare dealer quotes, and understand market dynamics. This opacity can exacerbate liquidity misallocation, lead to greater delays in trades, and increase the difference between buying and selling prices, making it more challenging for investors to navigate the OTC landscape and protect their investments.

Can you explain the three scenarios for trade execution in the OTC market that reflect the impact of liquidity misallocation?

The article describes three scenarios reflecting the impact of liquidity misallocation: 1) Trades with a small surplus: These trades might not happen at all because the dealer may not find it profitable to execute them. 2) Delayed Trades: Trades with an intermediate surplus may experience delays. The dealer might slow down execution if they believe they can extract more value from the trade later or from other clients. 3) High-Cost Trades: Trades with a high surplus (meaning the trader is willing to pay a significant premium) will likely be executed quickly, but with wider bid/ask spreads. This means the trader will pay a higher price for the asset, increasing the dealer's profit margin.

How can I make smarter investment decisions when navigating the Over-the-Counter (OTC) markets?

To make smarter investment decisions in Over-the-Counter (OTC) markets, it's crucial to understand the underlying dynamics and potential pitfalls. First, recognize the potential for liquidity misallocation and the influence of dealer strategies. Stay informed about market conditions, consider diversifying your trading strategies to mitigate risks, and seek expert advice to help navigate the complexities of OTC trading. Understanding the impact of market opacity and dealer behaviors is also key. By being proactive and informed, you can better manage your risk, seek opportunities for more efficient trading, and ultimately work towards achieving your financial goals.