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The market for OTC derivatives

  • Andrew Atkeson
  • Andrea L. Eisfeldt
  • Pierre-Olivier Weill

We develop a model of equilibrium entry, trade, and price formation in over-the-counter (OTC) markets. Banks trade derivatives to share an aggregate risk subject to two trading frictions: they must pay a fixed entry cost, and they must limit the size of the positions taken by their traders because of risk-management concerns. Although all banks in our model are endowed with access to the same trading technology, some large banks endogenously arise as “dealers,” trading mainly to provide intermediation services, while medium sized banks endogenously participate as “customers” mainly to share risks. We use the model to address positive questions regarding the growth in OTC markets as trading frictions decline, and normative questions of how regulation of entry impacts welfare.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 479.

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Date of creation: 2013
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Handle: RePEc:fip:fedmsr:479
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  1. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-32, March.
  2. Sergio Mayordomo & Juan Ignacio Peña & Eduardo S. Schwartz, 2010. "Are all Credit Default Swap Databases Equal?," NBER Working Papers 16590, National Bureau of Economic Research, Inc.
  3. Darrell Duffie & Semyon Malamud & Gustavo Manso, 2009. "Information Percolation With Equilibrium Search Dynamics," Econometrica, Econometric Society, vol. 77(5), pages 1513-1574, 09.
  4. Darrell Duffie & Bruno Strulovici, 2009. "Capital Mobility and Asset Pricing," Discussion Papers 1478, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Peter Kondor & Ana Babus, 2013. "Trading and Information Diffusion in Over-the-Counter Markets," 2013 Meeting Papers 792, Society for Economic Dynamics.
  6. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
  7. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
  8. Gara M. Afonso, 2008. "Liquidity and congestion," Staff Reports 349, Federal Reserve Bank of New York.
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