Working Paper: NBER ID: w18912
Authors: Andrew G. 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: OTC derivatives; market structure; trading frictions; regulation; entry
JEL Codes: D83; G00
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fixed entry costs and trading limits (G12) | only larger banks enter the OTC market (G21) |
| only larger banks enter the OTC market (G21) | concentration of intermediation activities among these banks (G21) |
| decline in trading frictions (F12) | market grows (G10) |
| regulatory changes affecting entry (L51) | improve market welfare (D60) |
| size and risk exposures of banks (G21) | roles as dealers and customers (L81) |