The impact of a dealer's failure on OTC derivatives market liquidity during volatile periods
Abstract: This paper develops a model in which information losses may be an important part of the cost of an OTC derivatives dealer's failure. A dealer failure forces solvent counterparties of a failed dealer to seek replacement hedges with other dealers. However, by forcing good firms into the derivatives market, the failure provides camouflage for insolvent firms seeking to speculate with a dealer that does not know their credit status. The paper models this information loss and uses the model to quantitatively evaluate a range of scenarios. The results suggest that a market breakdown is unlikely but not quite impossible.
File(s): File format is application/pdf https://www.frbatlanta.org/-/media/documents/research/publications/wp/1996/wp966.pdf
Provider: Federal Reserve Bank of Atlanta
Part of Series: FRB Atlanta Working Paper
Publication Date: 1996