Working Paper: CEPR ID: DP14258
Authors: Jerome Dugast; Semih Uslu; Pierre-Olivier Weill
Abstract: Should regulators encourage the migration of trade from over-the-counter (OTC) to centralizedmarkets? To address this question, we study a model in which banks make costly decisionsto participate in an OTC market, a centralized market, or both markets at the same time.Banks differ in their ability to take large positions, what we call their trading capacity. Inequilibrium, intermediate-capacity banks find it optimal to participate in the centralized market.In contrast, low- and high-capacity banks find it optimal to participate in the OTC market, dueto an endogenous complementarity. Namely, low capacity banks receive worse terms of trade thanin the centralized market but better risk sharing, thanks to the intermediation services offeredby high-capacity banks. High-capacity banks receive worse risk sharing than in the centralizedmarket, but profit from the provision of intermediation services to low-capacity banks. While thesocial optimum has qualitatively similar participation patterns, it prescribes that more customersmigrate to the centralized market, and that more dealers enter the OTC market.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trading capacity (E22) | market choice (D49) |
| high-capacity banks (G21) | OTC market participation (G19) |
| intermediate-capacity banks (G21) | centralized market participation (D40) |
| marginal banks (G21) | welfare improvements (I38) |
| low-capacity banks (G21) | centralized market welfare improvement (D61) |
| high-capacity banks (G21) | welfare reduction (I38) |