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The impact of non-cash collateralization on the over-the-counter derivatives markets

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  • Kazuhiro Takino

    (Nagoya University of Commerce and Business)

Abstract

In this study, we propose a microeconomics model to verify effects of the non-cash collateralization on the liquidity of the over-the-counter (OTC) derivatives markets accepting both cash and non-cash assets. Liquidity is measured as an equilibrium volume of the derivatives contract. The equilibrium volume is obtained by solving the utility maximization problem of a risk-averse collateral payer who wants to optimize her/his capital. The collateral payer’s capital depends on the non-cash asset used as collateral. We consider both option and forward contracts as examples. Our sensitivity analysis shows that the optimal combination of cash and non-cash collaterals can maximize the liquidity of derivatives. Especially for option contracts, the market requires both cash and non-cash collaterals for liquidity. The empirical result related to this finding is provided. Overall, the introduction of non-cash collateralization boosts the liquidity of derivatives contracts. We also show how the arrangements of collateralization can boost the liquidity of the OTC derivatives markets. Moreover, we demonstrate that the combination of cash and non-cash collaterals to maximize liquidity differs from that to maximize the participant’s utility. This indicates that the optimal combination is not efficient in terms of Pareto criteria.

Suggested Citation

  • Kazuhiro Takino, 2022. "The impact of non-cash collateralization on the over-the-counter derivatives markets," Review of Derivatives Research, Springer, vol. 25(2), pages 137-171, July.
    • Handle: RePEc:kap:revdev:v:25:y:2022:i:2:d:10.1007_s11147-021-09184-6
    DOI: 10.1007/s11147-021-09184-6
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    References listed on IDEAS

    as
    1. Michael Johannes & Suresh Sundaresan, 2007. "The Impact of Collateralization on Swap Rates," Journal of Finance, American Finance Association, vol. 62(1), pages 383-410, February.
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    More about this item

    Keywords

    OTC derivatives markets; Counterparty risk; Non-cash collateralization; Demand-supply analysis;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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