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A Theory of Participation in OTC and Centralized Markets

Author

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  • Jérôme Dugast

    (DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris sciences et lettres - CNRS - Centre National de la Recherche Scientifique)

  • Semih Üslü

    (Johns Hopkins University - Cancer Research Building 1)

  • Pierre-Olivier Weil

    (University of California - University of California)

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 participationof heterogeneous banks in an OTC market, in a centralized market, or in both markets at the sametime. We find that banks have the strongest private incentives to participate in the OTC market if theyhave the lowest risk-sharing needs and highest ability to take large positions. These banks endogenouslyassume the role of OTC market dealers. Other banks, with relatively higher risk-sharing needs andlower ability to take large positions, lie at the margin: they are indifferent between the centralizedmarket and the OTC market, where they endogenously assume the role of customers. We show thatmore customer bank participation in the centralized market can be welfare improving only if banksare mostly heterogeneous in their ability to take large positions in the OTC market, and if participationcosts induce banks to trade exclusively in one market. Empirical evidence suggests that these conditionsfor a welfare improvement are met.

Suggested Citation

  • Jérôme Dugast & Semih Üslü & Pierre-Olivier Weil, 2019. "A Theory of Participation in OTC and Centralized Markets," Working Papers hal-02303959, HAL.
  • Handle: RePEc:hal:wpaper:hal-02303959
    Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-02303959
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    3. Lebeau, Lucie, 2020. "Credit frictions and participation in over-the-counter markets," Journal of Economic Theory, Elsevier, vol. 189(C).

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    More about this item

    Keywords

    Asset Pricing; Economic Fluctuations; Growth; Monetary Economics;

    JEL classification:

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

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