Dealers’ Insurance, Market Structure, and Liquidity

78 Pages Posted: 8 May 2020

See all articles by Francesca Carapella

Francesca Carapella

Board of Governors of the Federal Reserve System

Cyril Monnet

University of Bern

Date Written: May 4, 2020

Abstract

We develop a parsimonious model to study the effect of regulations aimed at reducing counterparty risk on the structure of over-the-counter securities markets. We find that such regulations promote entry of dealers, thus fostering competition and lowering spreads. Greater competition, however, has an indirect negative effect on market-making profitability. General equilibrium effects imply that more competition can distort incentives of all dealers to invest in efficient technologies ex ante, and so can cause a social welfare loss. Our results are consistent with empirical findings on the effects of post-crisis regulations and with the opposition of some market participants to those regulations.

Keywords: liquidity, dealers, insurance, central counterparties

JEL Classification: G11, G23, G28

Suggested Citation

Carapella, Francesca and Monnet, Cyril, Dealers’ Insurance, Market Structure, and Liquidity (May 4, 2020). BIS Working Paper No. 861, Available at SSRN: https://ssrn.com/abstract=3592540

Francesca Carapella (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Cyril Monnet

University of Bern ( email )

Gesellschaftsstrasse 49
Bern, BERN 3001
Switzerland

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