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Banking Regulation and Market Making

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  • David A. Cimon
  • Corey Garriott

Abstract

We present a model of market makers subject to recent banking regulations: liquidity and capital constraints in the style of Basel III and a position limit in the style of the Volcker Rule. Regulation causes market makers to reduce their intermediation by refusing principal positions. However, it can improve the bid-ask spread because it induces new market makers to enter. Since market makers intermediate less, asset prices exhibit a liquidity premium. Costs of regulation can be assessed by measuring principal positions and asset prices but not by measuring bid-ask spreads.

Suggested Citation

  • David A. Cimon & Corey Garriott, 2017. "Banking Regulation and Market Making," Staff Working Papers 17-7, Bank of Canada.
    • Handle: RePEc:bca:bocawp:17-7
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    References listed on IDEAS

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    Cited by:

    1. Bank for International Settlements, 2017. "Repo market functioning," CGFS Papers, Bank for International Settlements, number 59.
    2. Chung-Yi Tse & Yujing Xu, 2021. "Inter-Dealer Trades in OTC Markets - Who Buys and Who Sells?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 39, pages 220-257, January.
    3. Jeffrey Gao & Jianjian Jin & Jacob Thompson, 2018. "The Impact of Government Debt Supply on Bond Market Liquidity: An Empirical Analysis of the Canadian Market," Staff Working Papers 18-35, Bank of Canada.
    4. Jean-Sébastien Fontaine & Corey Garriott & Jesse Johal & Jessica Lee & Andreas Uthemann, 2021. "COVID-19 Crisis: Lessons Learned for Future Policy Research," Discussion Papers 2021-2, Bank of Canada.
    5. Fardeau, Vincent, 2024. "Arbitrage with financial constraints and market power," Journal of Economic Theory, Elsevier, vol. 217(C).
    6. Fardeau, Vincent, 2023. "Sequential entry in illiquid markets," Journal of Financial Markets, Elsevier, vol. 64(C).
    7. Jaewon Choi & Yesol Huh & Sean Seunghun Shin, 2024. "Customer Liquidity Provision: Implications for Corporate Bond Transaction Costs," Management Science, INFORMS, vol. 70(1), pages 187-206, January.
    8. Bicu, Andreea & Chen, Louisa & Elliott, David, 2017. "The leverage ratio and liquidity in the gilt and repo markets," Bank of England working papers 690, Bank of England, revised 19 Dec 2017.
    9. Daniel Hyun & Jesse Johal & Corey Garriott, 2017. "Do Canadian Broker-Dealers Act as Agents or Principals in Bond Trading?," Staff Analytical Notes 17-11, Bank of Canada.
    10. Cimon, David A. & Walton, Adrian, 2024. "Central bank liquidity facilities and market making," Journal of Banking & Finance, Elsevier, vol. 162(C).
    11. Iñaki Aldasoro & Wenqian Huang & Nikola Tarashev, 2021. "Asset managers, market liquidity and bank regulation," BIS Working Papers 933, Bank for International Settlements.
    12. Bicu-Lieb, Andreea & Chen, Louisa & Elliott, David, 2020. "The leverage ratio and liquidity in the gilt and gilt repo markets," Journal of Financial Markets, Elsevier, vol. 48(C).
    13. Alain P. Chaboud & Caren Cox & Michael J. Fleming & Ellen Correia Golay & Yesol Huh & Frank M. Keane & Kyle Lee & Krista B. Schwarz & Clara Vega & Carolyn Windover, 2022. "All-to-All Trading in the U.S. Treasury Market," Staff Reports 1036, Federal Reserve Bank of New York.
    14. Marcin Czupryna, 2022. "Market makers activity: behavioural and agent based approach," Central European Journal of Operations Research, Springer;Slovak Society for Operations Research;Hungarian Operational Research Society;Czech Society for Operations Research;Österr. Gesellschaft für Operations Research (ÖGOR);Slovenian Society Informatika - Section for Operational Research;Croatian Operational Research Society, vol. 30(1), pages 303-322, March.
    15. Yu An & Zeyu Zheng, 2023. "Immediacy Provision and Matchmaking," Management Science, INFORMS, vol. 69(2), pages 1245-1263, February.
    16. Ali Uyar & Simone Pizzi & Fabio Caputo & Cemil Kuzey & Abdullah S. Karaman, 2022. "Do shareholders reward or punish risky firms due to CSR reporting and assurance?," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 43(5), pages 1596-1620, July.
    17. Huh, Yesol & Infante, Sebastian, 2021. "Bond market intermediation and the Role of Repo," Journal of Banking & Finance, Elsevier, vol. 122(C).

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    More about this item

    Keywords

    Financial markets; Financial system regulation and policies; Market structure and pricing;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General

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