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Strategic Relationships in Over-the-Counter Markets

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  • Ana Babus

    (Princeton University)

Abstract

This paper provides a theory of dynamic formation of relationships in over-the-counter markets. I show that in equilibrium markets are dealer-centric. Two forces drive the formation of networks of relationships that have a core-periphery structure. First, agents develop enduring relationships to trade risky assets over the counter against no collateral. Unsecured trading is feasible when traders are willing to incur losses in the bad states of the world, provided they are compensated sufficiently in the good states of the world. To enforce such contracts, traders rely on a network of relationships. Second, in a network, some agents may need to intermediate transactions between others and require compensation for it. This explains the emergence of a central broker-dealer that stands as counterparty for all trade.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 1405.

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Date of creation: 2011
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Handle: RePEc:red:sed011:1405

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Cited by:
  1. Jan-Peter Siedlarek, 2012. "Intermediation in Networks," Working Papers, Fondazione Eni Enrico Mattei 2012.42, Fondazione Eni Enrico Mattei.
  2. Bräuning, Falk & Fecht, Falko, 2012. "Relationship lending in the interbank market and the price of liquidity," Discussion Papers 22/2012, Deutsche Bundesbank, Research Centre.

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