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Compressing Over-the-Counter Markets

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  • Marco D'Errico
  • Tarik Roukny

Abstract

Over-the-counter markets are at the center of the postcrisis global reform of the financial system. We show how the size and structure of such markets can undergo rapid and extensive changes when participants engage in portfolio compression, a post-trade netting technology. Tightly-knit and concentrated trading structures, as featured by many large over-the-counter markets, are especially susceptible to reductions of notional and reconfigurations of network structure resulting from compression activities. Using transaction-level data on credit-default-swaps markets, we estimate reduction levels consistent with the historical development observed in these markets since the Global Financial Crisis. Finally, we study the effect of a mandate to centrally clear over-the-counter markets. When participants engage in both central clearing and portfolio compression, we find large netting failures if clearinghouses proliferate. Allowing for compression across clearinghouses by-and-large offsets this adverse effect.

Suggested Citation

  • Marco D'Errico & Tarik Roukny, 2017. "Compressing Over-the-Counter Markets," Papers 1705.07155, arXiv.org, revised Jun 2019.
  • Handle: RePEc:arx:papers:1705.07155
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    References listed on IDEAS

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    Cited by:

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    2. D’Errico, Marco & Battiston, Stefano & Peltonen, Tuomas & Scheicher, Martin, 2018. "How does risk flow in the credit default swap market?," Journal of Financial Stability, Elsevier, vol. 35(C), pages 53-74.
    3. Matthew O. Jackson & Agathe Pernoud, 2020. "Credit Freezes, Equilibrium Multiplicity, and Optimal Bailouts in Financial Networks," Papers 2012.12861, arXiv.org, revised Jul 2023.
    4. Hamed Amini & Zhongyuan Cao & Agnes Sulem, 2021. "Limit Theorems for Default Contagion and Systemic Risk," Papers 2104.00248, arXiv.org.
    5. Meglioli, Francesco & Gauci, Stephanie, 2021. "A Multi-level Network Approach to Spillovers Analysis: An Application to the Maltese Domestic Investment Funds Sector," ESRB Working Paper Series 124, European Systemic Risk Board.
    6. Hamed Amini & Zachary Feinstein, 2020. "Optimal Network Compression," Papers 2008.08733, arXiv.org, revised Jul 2022.
    7. Gai, Prasanna & Kemp, Malcolm & Sánchez Serrano, Antonio & Schnabel, Isabel, 2019. "Regulatory complexity and the quest for robust regulation," Report of the Advisory Scientific Committee 8, European Systemic Risk Board.
    8. Iman van Lelyveld & Sinziana Kroon, 2018. "Counterparty credit risk and the effectiveness of banking regulation," DNB Working Papers 599, Netherlands Central Bank, Research Department.

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