Market-Making Costs and Liquidity: Evidence from CDS Markets
Mark Paddrik and
Stathis Tompaidis ()
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Stathis Tompaidis: University of Texas at Austin
No 19-01, Working Papers from Office of Financial Research, US Department of the Treasury
Abstract:
In over-the-counter markets, dealers facilitate trading by becoming market makers. The costs dealers face, including the cost of holding inventory on balance sheet, and the ease, or difficulty, of reducing their positions, determine the degree of liquidity they provide. We provide a stylized model to examine the implications of these costs on dealer behavior and market liquidity. We use the model to guide an empirical study of the single-name credit default swap (CDS) market between 2010-2016. We find that transaction prices between dealers and clients have progressively become more dependent on the inventories of individual dealers rather than on the aggregate inventory across all dealers. We also find that the volume between clients and dealers decreases across all clients, with larger declines for clients that are depository institutions. At the same time, the volume of interdealer trades decreases, dealer inventories decline, and dealers with large inventories are more likely to trade with clients. Our results are consistent with the view that regulatory reforms implemented following the 2007-09 financial crisis increased the cost of holding inventory for dealers, and the cost of interdealer trading.
Keywords: credit default swaps; liquidity; market making; transaction costs (search for similar items in EconPapers)
Pages: 47 pages
Date: 2019-03-12
New Economics Papers: this item is included in nep-ban, nep-fmk and nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)
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https://www.financialresearch.gov/working-papers/f ... from-CDS-Markets.pdf First version, 2019 (application/pdf)
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Persistent link: https://EconPapers.repec.org/RePEc:ofr:wpaper:19-01
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