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Dealers’ insurance, market structure, and liquidity

Francesca Carapella and Cyril Monnet

Journal of Financial Economics, 2020, vol. 138, issue 3, 725-753

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.

Keywords: Liquidity; Dealers; Insurance; Central counterparties (search for similar items in EconPapers)
JEL-codes: G11 G23 G28 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.jfineco.2020.06.013

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