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A Theory of Participation in OTC and Centralized Markets

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  • Dugast, Jerome
  • Uslu, Semih
  • Weill, Pierre-Olivier

Abstract

Should regulators encourage the migration of trade from over-the-counter (OTC) to centralized markets? To address this question, we consider a model of equilibrium and socially optimal market participation of heterogeneous banks in an OTC market, in a centralized market, or in both markets at the same time. We find that banks have the strongest private incentives to participate in the OTC market if they have the lowest risk-sharing needs and highest ability to take large positions. These banks endogenously assume the role of OTC market dealers. Other banks, with relatively higher risk-sharing needs and lower ability to take large positions, lie at the margin: they are indifferent between the centralized market and the OTC market, where they endogenously assume the role of customers. We show that more customer bank participation in the centralized market can be welfare improving only if banks are mostly heterogeneous in their ability to take large positions in the OTC market, and if participation costs induce banks to trade exclusively in one market. Empirical evidence suggests that these conditions for a welfare improvement are met.

Suggested Citation

  • Dugast, Jerome & Uslu, Semih & Weill, Pierre-Olivier, 2019. "A Theory of Participation in OTC and Centralized Markets," CEPR Discussion Papers 14258, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:14258
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    Cited by:

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    3. Hu, Tai-Wei & Rocheteau, Guillaume, 2020. "Bargaining under liquidity constraints: Unified strategic foundations of the Nash and Kalai solutions," Journal of Economic Theory, Elsevier, vol. 189(C).
    4. Babus, Ana & Hachem, Kinda, 2021. "Regulation and security design in concentrated markets," Journal of Monetary Economics, Elsevier, vol. 121(C), pages 139-151.
    5. Jean‐Edouard Colliard & Thierry Foucault & Peter Hoffmann, 2021. "Inventory Management, Dealers' Connections, and Prices in Over‐the‐Counter Markets," Journal of Finance, American Finance Association, vol. 76(5), pages 2199-2247, October.
    6. Lebeau, Lucie, 2020. "Credit frictions and participation in over-the-counter markets," Journal of Economic Theory, Elsevier, vol. 189(C).

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    JEL classification:

    • G0 - Financial Economics - - General
    • G1 - Financial Economics - - General Financial Markets

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