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The impact of a dealer's failure on OTC derivatives market liquidity during volatile periods

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Author Info

  • Larry D. Wall
  • Ellis W. Tallman
  • Peter A. Abken

Abstract

This paper develops a model in which information losses may be an important part of the cost of an OTC derivatives dealer's failure. A dealer failure forces solvent counterparties of a failed dealer to seek replacement hedges with other dealers. However, by forcing good firms into the derivatives market, the failure provides camouflage for insolvent firms seeking to speculate with a dealer that does not know their credit status. The paper models this information loss and uses the model to quantitatively evaluate a range of scenarios. The results suggest that a market breakdown is unlikely but not quite impossible.

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File URL: http://www.frbatlanta.org/filelegacydocs/wp966.pdf
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Bibliographic Info

Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 96-6.

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Date of creation: 1996
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Handle: RePEc:fip:fedawp:96-6

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Keywords: Derivative securities ; Liquidity (Economics);

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Cited by:
  1. Wall, Larry D. & Eisenbeis, Robert A. & Frame, W. Scott, 2005. "Resolving large financial intermediaries: Banks versus housing enterprises," Journal of Financial Stability, Elsevier, vol. 1(3), pages 386-425, April.
  2. Hentschel, Ludger & Smith, Clifford Jr., 1997. "Derivatives regulation: Implications for central banks," Journal of Monetary Economics, Elsevier, vol. 40(2), pages 305-346, October.

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