Banking Regulation and Market Making
44 Pages Posted: 10 Dec 2016 Last revised: 8 Aug 2018
Date Written: August 6, 2018
Motivated by recent banking regulation, we study how securities dealers respond to constraints on the balance sheet. The constraints lead dealers to reduce their market making, specifically by refusing principal positions and instead matching clients on an agency basis. As a result, asset prices exhibit greater price impact and price pressure, since clients require price concessions to motivate them to be matched. While balance-sheet regulation in the style of Basel III decreases the risk of dealer default, the Volcker Rule does not necessarily.
Keywords: market making, market microstructure, fixed income, liquidity, regulation, Basel III, Volcker rule, securities financing
JEL Classification: G14, G20, L10
Suggested Citation: Suggested Citation