Would Greater Transparency Increase or Decrease Contracting Costs?
JOURNAL OF FINANCIAL ENGINEERING, Vol 4 No 2, June 1995
Posted: 25 Aug 1998
This article focuses on the regulatory goal of increasing the transparency of the OTC derivatives market. We show that users of these instruments employ the services of an intermediary in order to minimize the total cost of establishing a hedge position. Financial intermediation involves almost exclusively the production of various kinds of information which gives the intermediaries a comparative advantage in the development of financial products. Would increased transparency lower contracting costs? We conclude not. The decision to use an intermediary remains optimal even in the presence of informational asymmetries when compared with the alternative of contracting directly with a counterparty. In other words, the comparative advantage of the intermediary in the production of the various types of information that go in these contracts more than offsets the expected costs and risks that informational asymmetries impose on the counterparties.
JEL Classification: G13
Suggested Citation: Suggested Citation