Derivative Market Competition: OTC Market Versus Organized Derivative Exchanges, Issues 2004-2061
Recent regulatory initiatives in the United States have again raised the issue of a ''level regulatory and supervisory playing field'' and the degree of competition globally between over-the-counter (OTC) derivatives and organized derivative exchange (ODE) markets. This paper models some important aspects of how an ODE market interrelates with the OTC markets. It analyzes various ways in which an ODE market can respond to competition from the OTC markets and considers whether ODE markets would actually benefit from a more level playing field. Among other factors, such as different transaction costs, different abilities to mitigate credit risk play a significant role in determining the degree of competition between the two types of markets. This implies that a potentially important service ODE markets can provide OTC market participants is to extend clearing services to them. Such services would allow the OTC markets to focus more on providing less competitive contracts/innovations and instead customize its contracts to specific investors' risk preferences and needs.
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Comparative Statics and Model Results
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agents going long aggregate asset assumed bid/ask spread CBOT CFMA CFTC Changing the Variance Chicago Mercantile Exchange comparative static competition dimension contract hedging m-risk counterparty risk credit risk aversion customized contracts derivative exchange markets Duffie and Jackson Effect of Changing equation 19 equilibrium EUREX futures exchanges global hedging demand Hence high variance idiosyncratic risk increase innovation investors ISDA m-risk contract market competition market exposure market risk Market Transaction Cost market's risk aversion Maximization Problem model developed notional value ODE derivatives ODE Market Transaction optimal contract optimal demand Optimal ODE Market optimal transaction cost organized derivative exchange OTC contract hedging OTC derivatives OTC derivatives market OTC market's risk OTC transactions paper payoff potentially regulation regulatory and supervisory risk tolerance risky endowment Schinasi speculators swap systematic risk systemic risk total volume traded trading volume transaction volume utility function Var(m variance of m-risk yk.OTC YODE zero