Dealers’ insurance, market structure, and liquidity

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 a...

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Bibliographic Details
Published inJournal of financial economics Vol. 138; no. 3; pp. 725 - 753
Main Authors Carapella, Francesca, Monnet, Cyril
Format Journal Article
LanguageEnglish
Published Amsterdam Elsevier B.V 01.12.2020
Elsevier Sequoia S.A
Subjects
Central counterparties
Dealers
Insurance
Liquidity
Market structure
Profitability
Regulation
Securities markets
Social welfare
Stock markets
Stock prices
Dealers
Insurance
Central counterparties
G11
Liquidity
G23
G28
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Summary: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.
ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2020.06.013