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Banking Regulation and Market Making

Author

Listed:
  • David A. Cimon
  • Corey Garriott

Abstract

We present a model of market makers subject to recent banking regulations: liquidity and capital constraints in the style of Basel III and a position limit in the style of the Volcker Rule. Regulation causes market makers to reduce their intermediation by refusing principal positions. However, it can improve the bid-ask spread because it induces new market makers to enter. Since market makers intermediate less, asset prices exhibit a liquidity premium. Costs of regulation can be assessed by measuring principal positions and asset prices but not by measuring bid-ask spreads.

Suggested Citation

  • David A. Cimon & Corey Garriott, 2017. "Banking Regulation and Market Making," Staff Working Papers 17-7, Bank of Canada.
  • Handle: RePEc:bca:bocawp:17-7
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    File URL: https://www.bankofcanada.ca/wp-content/uploads/2017/02/swp2017-7.pdf
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    References listed on IDEAS

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    1. Nathan Foley-Fisher & Borghan Narajabad & Stephane Verani, 2016. "Securities Lending as Wholesale Funding: Evidence from the U.S. Life Insurance Industry," NBER Working Papers 22774, National Bureau of Economic Research, Inc.
    2. Bottazzi, Jean-Marc & Luque, Jaime & Páscoa, Mário R., 2012. "Securities market theory: Possession, repo and rehypothecation," Journal of Economic Theory, Elsevier, vol. 147(2), pages 477-500.
    3. Corey Garriott & Kyle Gray, 2016. "Canadian Repo Market Ecology," Discussion Papers 16-8, Bank of Canada.
    4. Liu, Hong & Wang, Yajun, 2016. "Market making with asymmetric information and inventory risk," Journal of Economic Theory, Elsevier, vol. 163(C), pages 73-109.
    5. James Pinnington & Maral Shamloo, 2016. "Limits to Arbitrage and Deviations from Covered Interest Rate Parity," Discussion Papers 16-4, Bank of Canada.
    6. Francesco Trebbi & Kairong Xiao, 2015. "Regulation and Market Liquidity," NBER Working Papers 21739, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Bank for International Settlements, 2017. "Repo market functioning," CGFS Papers, Bank for International Settlements, number 59, July.
    2. Daniel Hyun & Jesse Johal & Corey Garriott, 2017. "Do Canadian Broker-Dealers Act as Agents or Principals in Bond Trading?," Staff Analytical Notes 17-11, Bank of Canada.
    3. Jeffrey Gao & Jianjian Jin & Jacob Thompson, 2018. "The Impact of Government Debt Supply on Bond Market Liquidity: An Empirical Analysis of the Canadian Market," Staff Working Papers 18-35, Bank of Canada.
    4. Jaewon Choi & Yesol Huh, 2017. "Customer Liquidity Provision : Implications for Corporate Bond Transaction Costs," Finance and Economics Discussion Series 2017-116, Board of Governors of the Federal Reserve System (US).
    5. Bicu, Andreea & Chen, Louisa & Elliott, David, 2017. "The leverage ratio and liquidity in the gilt and repo markets," Bank of England working papers 690, Bank of England, revised 19 Dec 2017.

    More about this item

    Keywords

    Financial markets; Financial system regulation and policies; Market structure and pricing;

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General

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