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Trading models and liquidity provision in OTC derivatives markets

Author

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  • Smyth, Nick

    (Bank of England)

  • Wetherilt, Anne

    (Bank of England)

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.

Suggested Citation

  • Smyth, Nick & Wetherilt, Anne, 2011. "Trading models and liquidity provision in OTC derivatives markets," Bank of England Quarterly Bulletin, Bank of England, vol. 51(4), pages 331-340.
    • Handle: RePEc:boe:qbullt:0065
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    References listed on IDEAS

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    Cited by:

    1. Benos, Evangelos & Wetherilt, Anne & Zikes, Filip, 2013. "Financial Stability Paper No 25: The structure and dynamics of the UK CDS market," Bank of England Financial Stability Papers 25, Bank of England.
    2. Sidanius, Che & Wetherilt, Anne, 2012. "Financial Stability Paper No 14: Thoughts on determining central clearing eligibility of OTC derivatives," Bank of England Financial Stability Papers 14, Bank of England.
    3. Ivana Ruffini & Robert Steigerwald, 2014. "OTC Derivatives—A Primer on Market Infrastructure and Regulatory Policy," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 80-99.
    4. Havran, Dániel & Erb, Tamás, 2015. "Mit veszítünk a piaci súrlódásokkal?. A pénzügyi piacok mikrostruktúrája [Trading mechanisms and market frictions. Microstructure of the financial markets]," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(3), pages 229-262.

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