Working Paper: CEPR ID: DP9403
Authors: Andrew Atkeson; Andrea L. Eisfeldt; Pierre-Olivier Weill
Abstract: 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.
Keywords: Credit Default Swaps; Dealers; OTC Markets
JEL Codes: D83; G00
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Entry Decisions (M51) | Market Growth (O49) |
| Bank Size (G21) | Market Participation (L11) |
| Decrease in Trading Frictions (F12) | Market Growth (O49) |
| Improved Trading Technologies (F19) | Decrease in Net-to-Gross Notional Ratio (G19) |
| Enhanced Risk Management Practices (G38) | Increase in Customer-to-Customer Trades (D16) |
| Concentration of Large Dealer Banks (G21) | Socially Inefficient Outcomes (D61) |
| Encouragement of Smaller Banks (G21) | Improved Welfare (I39) |