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

Kazuhiro Takino ()
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Kazuhiro Takino: Nagoya University of Commerce and Business

Review of Derivatives Research, 2022, vol. 25, issue 2, No 2, 137-171

Abstract: 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.

Keywords: OTC derivatives markets; Counterparty risk; Non-cash collateralization; Demand-supply analysis (search for similar items in EconPapers)
JEL-codes: G10 G12 G13 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s11147-021-09184-6

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