Econometrica: Nov 2015, Volume 83, Issue 6

Entry and Exit in OTC Derivatives Markets

https://doi.org/10.3982/ECTA11477
p. 2231-2292

Andrew G. Atkeson, Andrea L. Eisfeldt, Pierre‐Olivier Weill

We develop a parsimonious model to study the equilibrium and socially optimal decisions of banks to enter, trade in, and possibly exit, an OTC market. Although we endow all banks with the same trading technology, banks' optimal entry and trading decisions endogenously lead to a realistic market structure composed of dealers and customers with distinct trading patterns. We decompose banks' entry incentives into incentives to hedge risk and incentives to make intermediation profits. We show that dealer banks enter more than is socially optimal. In the face of large negative shocks, they may also exit more than is socially optimal when markets are not perfectly resilient.

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Supplemental Material

Supplement to "Entry and Exit in OTC Derivatives Markets"

In this appendix we offer a complete analysis of the three type model.  Section B.1 characterizes the equilibrium conditional on entry.  Section B.2 shows that all entry equilibria and social optimal must be symmetric.  Section B.3 studies equilibrium entry, and Section B.4 studies the social optimum with entry.  B.5 characterizes the restrictions on market composition imposed by equilibrium and socially optimal entry.  Section B.6 studies the model when the bargaining weight of customers and dealers are asymmetric.  Section B.7 studies equilibrium exit, and Section B.8 studies the social optimum with exit.

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