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The market for OTC derivatives

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  • Andrew Atkeson
  • Andrea L. Eisfeldt
  • Pierre-Olivier Weill

Abstract

We develop a model of equilibrium entry, trade, and price formation in over-the-counter (OTC) markets. Banks trade derivatives to share an aggregate risk subject to two trading frictions: they must pay a fixed entry cost, and they must limit the size of the positions taken by their traders because of risk-management concerns. Although all banks in our model are endowed with access to the same trading technology, some large banks endogenously arise as “dealers,” trading mainly to provide intermediation services, while medium sized banks endogenously participate as “customers” mainly to share risks. We use the model to address positive questions regarding the growth in OTC markets as trading frictions decline, and normative questions of how regulation of entry impacts welfare.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 479.

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Date of creation: 2013
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Handle: RePEc:fip:fedmsr:479

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Keywords: Asset pricing;

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  1. Darrell Duffie & Bruno Strulovici, 2012. "Capital Mobility and Asset Pricing," Econometrica, Econometric Society, vol. 80(6), pages 2469-2509, November.
  2. Darrell DUFFIE & Semyon MALAMUD & Gustavo MANSO, . "Information Percolation with Equilibrium Search Dynamics," Swiss Finance Institute Research Paper Series 09-02, Swiss Finance Institute.
  3. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
  4. Gara M. Afonso, 2008. "Liquidity and congestion," Staff Reports 349, Federal Reserve Bank of New York.
  5. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  6. Ana Babus & Péter Kondor, 2012. "Trading and Information Diffusion in Over-the-Counter Markets," CEU Working Papers 2012_19, Department of Economics, Central European University, revised 09 Dec 2012.
  7. Sergio Mayordomo & Juan Ignacio Peña Sánchez de Rivera & Eduardo S. Schwartz, 2010. "Are all Credit Default Swap databases equal?," Business Economics Working Papers wb104621, Universidad Carlos III, Departamento de Economía de la Empresa.
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