Dealers’ insurance, market structure, and liquidity
Francesca Carapella and
Journal of Financial Economics, 2020, vol. 138, issue 3, 725-753
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)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:138:y:2020:i:3:p:725-753
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