Banking Regulation and Market Making

47 Pages Posted: 10 Dec 2016 Last revised: 23 Jul 2019

See all articles by David Cimon

David Cimon

Wilfrid Laurier University - School of Business & Economics

Corey Garriott

Bank of Canada

Date Written: July 22, 2019

Abstract

We model how securities dealers respond to regulations on leverage, position, and liquidity such as those imposed by the Basel III framework. The dealers respond by endogenously moving to make markets on an agency basis, matching buyers to sellers rather than taking client positions on the balance sheet. Agency-based market making creates a cost-risk tradeoff in which investor welfare declines but dealers become less risky. The costs to investors do not show up in all liquidity metrics: While asset prices exhibit greater price impact, bid-ask spreads do not change and trading volumes can even increase, which can help explain the varying findings from the empirical literature.

Keywords: banking regulation, market making, agency, liquidity

JEL Classification: G14, G20, L10

Suggested Citation

Cimon, David and Garriott, Corey, Banking Regulation and Market Making (July 22, 2019). Available at SSRN: https://ssrn.com/abstract=2882594 or http://dx.doi.org/10.2139/ssrn.2882594

David Cimon (Contact Author)

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada

Corey Garriott

Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada

HOME PAGE: http://https://cgarriott.wordpress.com/

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