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The impact of a dealer's failure on OTC derivatives market liquidity during volatile periods

  • Larry D. Wall
  • Ellis W. Tallman
  • Peter A. Abken

This paper develops a model in which information losses may be an important part of the cost of an OTC derivatives dealer's failure. A dealer failure forces solvent counterparties of a failed dealer to seek replacement hedges with other dealers. However, by forcing good firms into the derivatives market, the failure provides camouflage for insolvent firms seeking to speculate with a dealer that does not know their credit status. The paper models this information loss and uses the model to quantitatively evaluate a range of scenarios. The results suggest that a market breakdown is unlikely but not quite impossible.

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Paper provided by Federal Reserve Bank of Atlanta in its series FRB Atlanta Working Paper No. with number 96-6.

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Date of creation: 1996
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Handle: RePEc:fip:fedawp:96-6
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