Working Paper: NBER ID: w25887
Authors: Jérôme Dugast; Semih S. Uslu; Pierre-Olivier Weill
Abstract: Should regulators encourage the migration of trade from over-the-counter (OTC) to centralized markets? To address this question, we study a model in which banks make costly decisions to 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. In equilibrium, 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, due to an endogenous complementarity. Namely, low capacity banks receive worse terms of trade than in the centralized market but better risk sharing, thanks to the intermediation services offered by high-capacity banks. High-capacity banks receive worse risk sharing than in the centralized market, but profit from the provision of intermediation services to low-capacity banks. While the social optimum has qualitatively similar participation patterns, it prescribes that more customers migrate to the centralized market, and that more dealers enter the OTC market.
Keywords: OTC Markets; Centralized Markets; Market Participation; Welfare; Trading Capacity
JEL Codes: G00; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trading capacity (E22) | market participation (L19) |
| market participation (L19) | welfare outcomes (I38) |
| low-capacity banks (G21) | prefer OTC markets (G19) |
| high-capacity banks (G21) | prefer OTC markets (G19) |
| intermediate-capacity banks (G21) | prefer centralized markets (D40) |
| reallocating banks from OTC to centralized markets (G18) | welfare improvements (I38) |
| reallocating banks without inducing match creation (G21) | negative welfare impact (D62) |
| social planner's solution (D51) | more participation from high-capacity banks in OTC markets (E44) |