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Contagion in Dealer Networks

Author

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  • Jean-Sébastien Fontaine
  • Adrian Walton

Abstract

Dealers connect investors who want to buy or sell securities in financial markets. Over time, dealers and investors form trading networks to save time and resources. An emerging field of research investigates how networks form. Using detailed data on trades in Government of Canada bonds, we reconstruct dealer networks and document how they respond to the release of relevant economic information. On one hand, we find that networks handle larger volumes of transactions and become more complex. On the other hand, we document more frequent and more severe contagion of settlement fails across dealer networks following these information releases. Settlement fails are unexpected delays in a buyer receiving bonds from a seller, creating counterparty risk and potential disruption to trading. Our findings suggest a trade-off. Large, complex dealer networks effectively connect investors but are also associated with contagion and an increase in counterparty risk due to settlement fails. One way to simplify dealer networks is through a central counterparty (CCP). A CCP reduces settlement volume, making fails less likely.

Suggested Citation

  • Jean-Sébastien Fontaine & Adrian Walton, 2020. "Contagion in Dealer Networks," Staff Working Papers 20-1, Bank of Canada.
    • Handle: RePEc:bca:bocawp:20-1
    DOI: 10.34989/swp-2020-1
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    References listed on IDEAS

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    Cited by:

    1. Domenico Di Gangi & Vladimir Lazarov & Aakash Mankodi & Laura Silvestri, 2022. "Links between government bond and futures markets: dealer-client relationships and price discovery in the UK," Bank of England working papers 991, Bank of England.

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    Keywords

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    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • G1 - Financial Economics - - General Financial Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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