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Mechanism Selection and Trade Formation on Swap Execution Facilities: Evidence from Index CDS

47 Pages Posted: 4 Oct 2017 Last revised: 6 Oct 2017

Lynn Riggs

Commodity Futures Trading Commission (CFTC)

Esen Onur

Commodity Futures Trading Commission (CFTC)

David Reiffen

U.S. Commodity Futures Trading Commission (CFTC)

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: September 29, 2017

Abstract

The Dodd-Frank Act mandates that certain standard OTC derivatives be traded on swap execution facilities (SEF). This paper provides a granular analysis of SEF trading mechanisms, using message-level data for May 2016 from the two largest customer-to-dealer SEFs in index CDS markets. Both SEFs offer various execution mechanisms that differ in how widely customers' trading interests are exposed to dealers. A theoretical model shows that although exposing the order to more dealers increases competition, it also causes a more severe winner's curse. Consistent with this trade-off, the data show that customers contact fewer dealers if the trade size is larger or nonstandard. Dealers are more likely to respond to customers' inquiries if fewer dealers are involved in competition, if the notional size is larger, or if more dealers are making markets. Finally, dealers' quoted spreads and customers' transaction costs increase in notional quantity and the number of dealers involved. In addition to results related to the winner's curse, past trading relationships also affect customers' requests and dealers' responses. Our results contribute to the understanding of swaps markets by providing insights into the trade-offs faced by investors and dealers.

Keywords: Swap Execution Facility, Dodd-Frank Act, OTC Derivatives, Competition, Winner's Curse

JEL Classification: G01, G12, G14, G18

Suggested Citation

Riggs, Lynn and Onur, Esen and Reiffen, David and Zhu, Haoxiang, Mechanism Selection and Trade Formation on Swap Execution Facilities: Evidence from Index CDS (September 29, 2017). Available at SSRN: https://ssrn.com/abstract=3047284

Lynn Riggs

Commodity Futures Trading Commission (CFTC) ( email )

1155 21st Street NW
Washington, DC 20581
United States

Esen Onur

Commodity Futures Trading Commission (CFTC) ( email )

1155 21st Street NW
Washington, DC 20581
United States

David Reiffen

U.S. Commodity Futures Trading Commission (CFTC) ( email )

Three Lafayette Centre
1155 21st Street, NW
Washington, DC 20581
United States

Haoxiang Zhu (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street E62-623
Cambridge, MA 02142
United States

HOME PAGE: http://www.mit.edu/~zhuh

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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