Compressing Over-the-Counter Markets

75 Pages Posted: 5 Nov 2020

See all articles by Marco D'Errico

Marco D'Errico

University of Zurich; European Systemic Risk Board

Tarik Roukny

Massachusetts Institute of Technology (MIT); KU Leuven - Faculty of Business and Economics (FEB)

Multiple version iconThere are 2 versions of this paper

Date Written: May, 2017

Abstract

In this paper, we show both theoretically and empirically that the size of over-the-counter (OTC) markets can be reduced without affecting individual net positions. First, we find that the networked nature of these markets generates an excess of notional obligations between the aggregate gross amount and the minimum amount required to satisfy each individual net position. Second, we show conditions under which such excess can be removed. We refer to this netting operation as compression and identify feasibility and efficiency criteria, highlighting intermediation as the key element for excess levels. We show that a tradeoff exists between the amount of notional that can be eliminated from the system and the conservation of original trading relationships. Third, we apply our framework to a unique and comprehensive transaction-level dataset on OTC derivatives including all firms based in the European Union. On average, we find that around 75% of market gross notional relates to excess. While around 50% can in general be removed via bilateral compression, more sophisticated multilateral compression approaches are substantially more efficient. In particular, we find that even the most conservative multilateral approach which satisfies relationship constraints can eliminate up to 98% of excess in the markets.

Keywords: compression, derivatives, intermediation, networks, optimization, OTC markets

JEL Classification: C61, D53, D85, G01, G10, G12

Suggested Citation

D'Errico, Marco and Roukny, Tarik, Compressing Over-the-Counter Markets (May, 2017). ESRB: Working Paper Series No. 2017/44, Available at SSRN: https://ssrn.com/abstract=3723391

Marco D'Errico (Contact Author)

University of Zurich

Andreasstrasse 15
Zurich, 8050
Switzerland

European Systemic Risk Board ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Tarik Roukny

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

KU Leuven - Faculty of Business and Economics (FEB) ( email )

Naamsestraat 69
Leuven, B-3000
Belgium

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