A Theory of Participation in OTC and Centralized Markets

67 Pages Posted: 13 Jun 2019 Last revised: 2 Oct 2019

See all articles by Jérôme Dugast

Jérôme Dugast

Université Paris Dauphine - Department of Finance

Semih Uslu

Johns Hopkins Carey Business School

Pierre-Olivier Weill

University of California, Los Angeles; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: May 28, 2019

Abstract

Should regulators encourage the migration of trade from over-the-counter (OTC) to centralized markets? To address this question, we consider a model of equilibrium and socially optimal market participation of heterogeneous banks in an OTC market, in a centralized market, or in both markets at the same time. We find that banks have the strongest private incentives to participate in the OTC market if they have the lowest risk-sharing needs and highest ability to take large positions. These banks endogenously assume the role of OTC market dealers. Other banks, with relatively higher risk-sharing needs and lower ability to take large positions, lie at the margin: they are indifferent between the centralized market and the OTC market, where they endogenously assume the role of customers. We show that more customer bank participation in the centralized market can be welfare improving only if banks are mostly heterogeneous in their ability to take large positions in the OTC market, and if participation costs induce banks to trade exclusively in one market. Empirical evidence suggests that these conditions for a welfare improvement are met.

Keywords: OTC Markets, Heterogeneity, Intermediation, Composition Externalities, Government Intervention

JEL Classification: G0, G1

Suggested Citation

Dugast, Jérôme and Uslu, Semih and Weill, Pierre-Olivier, A Theory of Participation in OTC and Centralized Markets (May 28, 2019). Johns Hopkins Carey Business School Research Paper No. 19-07. Available at SSRN: https://ssrn.com/abstract=3395607 or http://dx.doi.org/10.2139/ssrn.3395607

Jérôme Dugast

Université Paris Dauphine - Department of Finance ( email )

Place du Maréchal de Lattre de Tassigny
Paris Cedex 16, 75775
France
+33 1 44 05 40 41 (Phone)

HOME PAGE: http://https://sites.google.com/view/jeromedugast/home

Semih Uslu (Contact Author)

Johns Hopkins Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States
410-234-9237 (Phone)

HOME PAGE: http://www.semihuslu.info

Pierre-Olivier Weill

University of California, Los Angeles ( email )

Box 951477
Los Angeles, CA 90095-1477
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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