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Trading models and liquidity provision in OTC derivatives markets

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Author Info

  • Smyth, Nick

    ()
    (Bank of England)

  • Wetherilt, Anne

    ()
    (Bank of England)

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    Abstract

    As part of a G20 commitment to improve transparency and mitigate systemic risk in derivatives markets, many OTC derivatives will be required to be traded on exchanges or electronic platforms by the end of 2012. It is important that liquidity on the new trading platforms is resilient, both during normal and stressed market conditions. This article discusses how liquidity is provided in different trading models and how liquidity resilience can be achieved. The article shows that liquidity provision depends on many factors, including the willingness of dealers to provide continuous prices, their ability to manage the inventory risk arising from their role as market makers, and the ability of customers to execute large or sensitive trades with minimum price impact. The article also suggests that conceptually, liquidity resilience can be achieved in a variety of trading models.

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    File URL: http://www.bankofengland.co.uk/publications/quarterlybulletin/qb110404.pdf
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    Bibliographic Info

    Article provided by Bank of England in its journal Bank of England Quarterly Bulletin.

    Volume (Year): 51 (2011)
    Issue (Month): 4 ()
    Pages: 331-340

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    Handle: RePEc:boe:qbullt:0065

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    1. Bruno Biais & David Martimort & Jean-Charles Rochet, 2000. "Competing Mechanisms in a Common Value Environment," Econometrica, Econometric Society, vol. 68(4), pages 799-838, July.
    2. Toni Gravelle, 2002. "The Microstructure of Multiple-Dealer Equity and Government Securities Markets: How They Differ," Working Papers 02-9, Bank of Canada.
    3. Kathryn Chen & Michael Fleming & John Jackson & Ada Li & Asani Sarkar, 2011. "An analysis of CDS transactions: implications for public reporting," Staff Reports 517, Federal Reserve Bank of New York.
    4. Madhavan, Ananth, 2000. "Market microstructure: A survey," Journal of Financial Markets, Elsevier, vol. 3(3), pages 205-258, August.
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