Abstract
Many financial markets are populated by dealers, who commit to regularly participate in the market, and non-dealers who do not commit. This market structure introduces a trade-off between competition and volatility, which we study using data on Canadian Treasury auctions. We document a consistent exit trend by dealers and increasing, but irregular participation by non-dealer hedge funds. Using a structural model, we evaluate the impact of dealer exit on hedge fund participation and its consequences on market competition and volatility. We find that hedge fund entry was partially driven by dealer exit, and that gains thanks to stronger competition associated with hedge fund entry are off-set by losses due to their irregular market participation. We propose an issuance policy that stabilizes hedge fund participation at a sufficiently high average level and achieves sizable revenue gains.