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Contagion in Dealer Networks

Jean-Sebastien Fontaine () and Adrian Walton

Staff Working Papers from Bank of Canada

Abstract: Dealers connect investors who want to buy or sell securities in financial markets. Over time, dealers and investors form trading networks to save time and resources. An emerging field of research investigates how networks form. Using detailed data on trades in Government of Canada bonds, we reconstruct dealer networks and document how they respond to the release of relevant economic information. On one hand, we find that networks handle larger volumes of transactions and become more complex. On the other hand, we document more frequent and more severe contagion of settlement fails across dealer networks following these information releases. Settlement fails are unexpected delays in a buyer receiving bonds from a seller, creating counterparty risk and potential disruption to trading. Our findings suggest a trade-off. Large, complex dealer networks effectively connect investors but are also associated with contagion and an increase in counterparty risk due to settlement fails. One way to simplify dealer networks is through a central counterparty (CCP). A CCP reduces settlement volume, making fails less likely.

Keywords: Financial markets; Market structure and pricing; Payment clearing and settlement systems (search for similar items in EconPapers)
JEL-codes: E4 G1 G21 L14 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2020-01
New Economics Papers: this item is included in nep-mac, nep-mst, nep-net and nep-pay
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:20-1

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