Counterparty Risk Externality: Centralized Versus Over-the-counter Markets
We model the opacity of over-the-counter (OTC) markets in a setup where agents share risks, but have incentives to default and their financial positions are not mutually observable. We show that this setup results in excess "leverage" in that parties take on short OTC positions that lead to levels of default risk that are higher than Pareto-efficient ones. In particular, OTC markets feature a "counterparty risk externality" that we show can lead to ex-ante productive inefficiency. This externality is absent when trading is organized via a centralized clearing mechanism that provides transparency of trade positions, or a centralized counterparty (such as an exchange) that observes all trades and sets prices competitively. While collateral requirements and subordination of OTC positions in bankruptcy can ameliorate the counterparty risk externality, they are in general inadequate in addressing it fully.
|Date of creation:||Apr 2011|
|Publication status:||published as “Counterparty Risk Externality: Centralized versus Over - the - counter Markets” with Alberto Bisin, Journal of Economic Theory , 2014, 149 , 153 - 182|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Christine A. Parlour & Guillaume Plantin, 2008. "Loan Sales and Relationship Banking," Journal of Finance, American Finance Association, vol. 63(3), pages 1291-1314, 06.
- Gregory R. Duffee & Chunsheng Zhou, 1997.
"Credit derivatives in banking: useful tools for managing risk?,"
Finance and Economics Discussion Series
1997-13, Board of Governors of the Federal Reserve System (U.S.).
- Duffee, Gregory R. & Zhou, Chunsheng, 2001. "Credit derivatives in banking: Useful tools for managing risk?," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 25-54, August.
- Gregory R. Duffee and Chunsheng Zhou., 1999. "Credit Derivatives in Banking: Useful Tools for Managing Risk?," Research Program in Finance Working Papers RPF-289, University of California at Berkeley.
- Duffee, Gregory R. & Zhou, Chunseng, 1999. "Credit Derivatives in Banking: Useful Tools for Managing Risk?," Research Program in Finance, Working Paper Series qt7g67n911, Research Program in Finance, Institute for Business and Economic Research, UC Berkeley.
- Tano Santos & José A. Scheinkman, 2000.
"Competition Among Exchanges,"
CRSP working papers
514, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
- Alberto Bisin & John Geanakoplos & Piero Gottardi & Enrico Minelli & Heracles Polemarchakis, 2009.
"Markets and Contracts,"
0915, University of Brescia, Department of Economics.
- P. Dubey & J. Geanakoplos & M . Shubik, 2001.
"Default and Punishment in General Equilibrium,"
Department of Economics Working Papers
01-07, Stony Brook University, Department of Economics.
- Pradeep Dubey & John Geanakoplos & Martin Shubik, 2001. "Default and Punishment in General Equilibrium," Cowles Foundation Discussion Papers 1304, Cowles Foundation for Research in Economics, Yale University.
- Pradeep Dubey & John Geanakoplos & Martin Shubik, 2001. "Default and Punishment in General Equilibrium," Cowles Foundation Discussion Papers 1304R5, Cowles Foundation for Research in Economics, Yale University, revised Mar 2004.
- Bizer, David S & DeMarzo, Peter M, 1992. "Sequential Banking," Journal of Political Economy, University of Chicago Press, vol. 100(1), pages 41-61, February.
- Bisin, A. & Guaitoli, D., 1998.
"Moral Hazard and Non-Exclusive Contracts,"
98-24, C.V. Starr Center for Applied Economics, New York University.
- Bisin, Alberto & Guaitoli, Danilo, 1998. "Moral Hazard and Non-Exclusive Contracts," CEPR Discussion Papers 1987, C.E.P.R. Discussion Papers.
- Alberto Bisin & Danilo Guaitoli, 1998. "Moral hazard and non-exclusive contracts," Economics Working Papers 345, Department of Economics and Business, Universitat Pompeu Fabra.
- Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2004.
NBER Working Papers
10816, National Bureau of Economic Research, Inc.
- Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2005. "Over-the-Counter Markets," Econometrica, Econometric Society, vol. 73(6), pages 1815-1847, November.
- Darrell Duffie, 2012. "Over-The-Counter Markets," Introductory Chapters, in: Dark Markets: Asset Pricing and Information Transmission in Over-the-Counter Markets Princeton University Press.
- Ricardo J. Caballero & Alp Simsek, 2009. "Complexity and Financial Panics," NBER Working Papers 14997, National Bureau of Economic Research, Inc.
- Bisin, Alberto & Rampini, Adriano A., 2006.
"Markets as beneficial constraints on the government,"
Journal of Public Economics,
Elsevier, vol. 90(4-5), pages 601-629, May.
- Adriano Rampini & Alberto Bisin, 2005. "Markets as Beneficial Constraints on the Government," 2005 Meeting Papers 325, Society for Economic Dynamics.
- Viral V. Acharya & Alberto Bisin, 2009. "Managerial hedging, equity ownership, and firm value," RAND Journal of Economics, RAND Corporation, vol. 40(1), pages 47-77.
- Acharya, Viral V. & Johnson, Timothy C., 2007.
"Insider trading in credit derivatives,"
Journal of Financial Economics,
Elsevier, vol. 84(1), pages 110-141, April.
- James R. Thompson, 2010. "Counterparty Risk in Financial Contracts: Should the Insured Worry About the Insurer?," The Quarterly Journal of Economics, Oxford University Press, vol. 125(3), pages 1195-1252.
- Darrell Duffie & Nicolae Gârleanu & Lasse Heje Pedersen, 2007.
"Valuation in Over-the-Counter Markets,"
Review of Financial Studies,
Society for Financial Studies, vol. 20(6), pages 1865-1900, November.
- Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2006. "Valuation in Over-the-Counter Markets," NBER Working Papers 12020, National Bureau of Economic Research, Inc.
- Duffie, Darrell & Garleanu, Nicolae Bogdan & Pedersen, Lasse Heje, 2006. "Valuation in Over-the-Counter Markets," CEPR Discussion Papers 5491, C.E.P.R. Discussion Papers.
- Christine A. Parlour & Uday Rajan, 2001. "Competition in Loan Contracts," American Economic Review, American Economic Association, vol. 91(5), pages 1311-1328, December.
- Alberto Bisin & Adriano Rampini, 2006. "Exclusive contracts and the institution of bankruptcy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 27(2), pages 277-304, January.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:17000. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.