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Dealers’ insurance, market structure, and liquidity

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  • Carapella, Francesca
  • Monnet, Cyril

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.

Suggested Citation

  • Carapella, Francesca & Monnet, Cyril, 2020. "Dealers’ insurance, market structure, and liquidity," Journal of Financial Economics, Elsevier, vol. 138(3), pages 725-753.
    • Handle: RePEc:eee:jfinec:v:138:y:2020:i:3:p:725-753
    DOI: 10.1016/j.jfineco.2020.06.013
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    1. Christina Brinkmann, 2023. "Differentiation in Risk Profiles," CRC TR 224 Discussion Paper Series crctr224_2023_444, University of Bonn and University of Mannheim, Germany.
    2. Christina Brinkmann, 2022. "Imperfect Competition in Derivatives Markets," ECONtribute Discussion Papers Series 153, University of Bonn and University of Cologne, Germany.

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    More about this item

    Keywords

    Liquidity; Dealers; Insurance; Central counterparties;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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