Hostname: page-component-78c5997874-8bhkd Total loading time: 0 Render date: 2024-11-02T19:53:54.476Z Has data issue: false hasContentIssue false
  • English
  • Français

Centralized Trading, Transparency, and Interest Rate Swap Market Liquidity: Evidence from the Implementation of the Dodd–Frank Act

Published online by Cambridge University Press:  03 December 2018

Evangelos Benos ,
Richard Payne  and
Michalis Vasios
Get access Rights & Permissions [Opens in a new window]

Abstract

We use proprietary transaction data on interest rate swaps to assess the effects of centralized trading, as mandated by Dodd–Frank, on market quality. Contracts with the most extensive centralized trading see liquidity metrics improve by between 12% and 19% relative to those of a control group. This is driven by a clear increase in competition between dealers, particularly in U.S. markets. Additionally, centralized trading has caused interdealer trading in EUR swap markets to migrate from the United States to Europe. This is consistent with swap dealers attempting to avoid being captured by the trade mandate in order to maintain market power.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 1 , February 2020 , pp. 159 - 192
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

1

We are grateful to Hendrik Bessembinder (the editor), Jean-Edouard Colliard (discussant), Thierry Foucault (the referee), Michael Moore (discussant), Emil Siriwardane (discussant), Peter Van Tassel (discussant), David Bailey, Paul Bedford, Darrell Duffie, Pedro Gurrola-Perez, Wenqian Huang, Esen Onur, Angelo Ranaldo, Rhiannon Sowerbutts, Chester Spatt, and seminar participants at the Bank of England, the Bank of Greece, the Bank of Lithuania, the U.S. Commodity Futures Trading Commission (CFTC), the U.S. Securities and Exchange Commission (SEC), the European Securities and Markets Authority (ESMA), the European Systemic Risk Board (ESRB), the Federal Reserve Board, the U.K. Financial Conduct Authority (FCA), the 2016 Annual Central Bank conference on the Microstructure of Financial Markets, the 2016 European Finance Association meeting, the 2017 American Finance Association meeting, the 2017 conference on OTC derivatives at the New York Fed, the 2017 Midwest Finance Association meetings, the 2017 conference on OTC Markets and their Reform, the Brunel University, the University of Belfast, the University of Gothenburg, the University of St. Gallen, and the University of Southampton for helpful comments and suggestions. The views expressed in this paper are those of the authors and not necessarily those of the Bank of England.

References

Acharya, V.; Engle, R.; Figlewski, S.; Lynch, A.; and Subrahmanyam, M.. “Centralized Clearing for Credit Derivatives.” In Restoring Financial Stability: How to Repair a Failed System, Acharya, V. and Richardson, M., eds. Hoboken, NJ: John Wiley & Sons Inc (2009).Google Scholar
Amihud, Y.“Illiquidity and Stock Returns: Cross-section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 31–56.Google Scholar
Bank for International Settlements. “OTC Derivatives Statistics at End–June 2016.” (2016).Google Scholar
Benos, E., and Žikeš, F.. “Funding Constraints and Liquidity in Two-Tiered OTC Markets.” Journal of Financial Markets, 39 (2018), 24–43.Google Scholar
Bessembinder, H.; Maxwell, W.; and Venkataraman, K.. “Market Transparency, Liquidity Externalities, and Institutional Trading Costs in Corporate Bonds.” Journal of Financial Economics, 82 (2006), 251–288.Google Scholar
Boehmer, E.; Saar, G.; and Yu, L.. “Lifting the Veil: An Analysis of Pre-Trade Transparency at the NYSE.” Journal of Finance, 60 (2005), 783–815.Google Scholar
Collin-Dufresne, P.; Junge, B.; and Trolle, A.. “Market Structure and Transaction Costs of Index CDSs.” Working Paper, Swiss Finance Institute (2016).Google Scholar
de Frutos, A., and Manzano, C.. “Risk Aversion, Transparency, and Market Performance.” Journal of Finance, 57 (2002), 959–984.Google Scholar
Duffie, D.; Gârleanu, N.; and Pedersen, L. H.. “Over-the-Counter Markets.” Econometrica, 73 (2005), 1815–1847.Google Scholar
Duffie, D., and Zhu, H.. “Size Discovery.” Review of Financial Studies, 30 (2017), 1095–1150.Google Scholar
Edwards, A. K.; Harris, L. E.; and Piwowar, M. S.. “Corporate Bond Market Transaction Costs and Transparency.” Journal of Finance, 62 (2007), 1421–1451.Google Scholar
Flood, M. D.; Huisman, R.; Koedijk, K. G.; and Mahieu, R. J.. “Quote Disclosure and Price Discovery in Multiple-Dealer Financial Markets.” Review of Financial Studies, 12 (1999), 37–59.Google Scholar
Foucault, T.; Moinas, S.; and Theissen, E.. “Does Anonymity Matter in Electronic Limit Order Markets?” Review of Financial Studies, 20 (2007), 1707–1747.Google Scholar
Foucault, T.; Pagano, M.; and Röell, A.. Market Liquidity: Theory, Evidence and Policy. New York, NY: Oxford University Press (2013).Google Scholar
Friederich, S., and Payne, R.. “Trading Anonymity and Order Anticipation.” Journal of Financial Markets, 21 (2014), 1–24.Google Scholar
Friewald, N.; Jankowitsch, R.; and Subrahmanyam, M. G.. “Illiquidity or Credit Deterioration: A Study of Liquidity in the US Corporate Bond Market During Financial Crises.” Journal of Financial Economics, 105 (2012), 18–36.Google Scholar
Friewald, N.; Jankowitsch, R.; and Subrahmanyam, M. G.. “Transparency and Liquidity in the Structured Product Market.” Review of Asset Pricing Studies, 7 (2017), 316–348.Google Scholar
Giancarlo, C.“Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank.” White Paper, U.S. Commodity Futures Trading Commission (2015).Google Scholar
Goldstein, M. A.; Hotchkiss, E. S.; and Sirri, E. R.. “Transparency and Liquidity: A Controlled Experiment on Corporate Bonds.” Review of Financial Studies, 20 (2007), 235–273.Google Scholar
Goyenko, R. Y.; Holden, C. W.; and Trzcinka, C. A.. “Do Liquidity Measures Measure Liquidity?” Journal of Financial Economics, 92 (2009), 153–181.Google Scholar
Green, R. C.; Hollifield, B.; and Schürhoff, N.. “Financial Intermediation and the Costs of Trading in an Opaque Market.” Review of Financial Studies, 20 (2006), 275–314.Google Scholar
Harris, L. E., and Piwowar, M. S.. “Secondary Trading Costs in the Municipal Bond Market.” Journal of Finance, 61 (2006), 1361–1397.Google Scholar
Hendershott, T., and Madhavan, A.. “Click or Call? Auction versus Search in the Over-the-Counter Market.” Journal of Finance, 70 (2015), 419–447.Google Scholar
ISDA. “Cross-Border Fragmentation of Global OTC Derivatives: An Empirical Analysis.” Research Note (2014).Google Scholar
Jankowitsch, R.; Nashikkar, A.; and Subrahmanyam, M. G.. “Price Dispersion in OTC Markets: A New Measure of Liquidity.” Journal of Banking & Finance, 35 (2011), 343–357.Google Scholar
Loon, Y. C., and Zhong, Z. K.. “The Impact of Central Clearing on Counterparty Risk, Liquidity, and Trading: Evidence from the Credit Default Swap Market.” Journal of Financial Economics, 112 (2014), 91–115.Google Scholar
Loon, Y. C., and Zhong, Z. K.. “Does Dodd-Frank Affect OTC Transaction Costs and Liquidity? Evidence from Real-Time CDS Trade Reports.” Journal of Financial Economics, 119 (2016), 645–672.Google Scholar
Massad, T.“Testimony of Chairman Timothy G. Massad Before the U.S. House Committee on Agriculture.” Available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-41 (2016).Google Scholar
Naik, N. Y.; Neuberger, A.; and Viswanathan, S.. “Trade Disclosure Regulation in Markets with Negotiated Trades.” Review of Financial Studies, 12 (1999), 873–900.Google Scholar
Nolte, I.; Payne, R.; and Vasios, M.. “Profiting from Mimicking Strategies in Non-Anonymous Markets.” Working Paper, Warwick Business School (2015).Google Scholar
Powell, J.“Trends in Fixed Income Markets: Testimony of Governor Jerome H. Powell Before the Subcommittee on Securities, Insurance, and Investment, and Subcommittee on Economic Policy, Committee on Banking, Housing, and Urban Affairs.” Available at http://www.federalreserve.gov/newsevents/testimony/powell20160414.htm (2016).Google Scholar
Riggs, L.; Onur, E.; Reiffen, D.; and Zhu, H.. “Swap Trading after Dodd-Frank: Evidence from Index CDS.” Working Paper, MIT Sloan School of Management (2018).Google Scholar
Spatt, C.“Designing Reliable Clearing and Settlement Systems for Enhancing the Transparency and Stability of Derivatives Markets.” Working Paper, Carnegie Mellon University (2017).Google Scholar
Vayanos, D., and Wang, J.. “Market Liquidity–Theory and Empirical Evidence.” National Bureau of Economic Research Working Paper No. w18251 (2012).Google Scholar
Žikeš, F.“Measuring Transaction Costs in the Absence of Timestamps.” Finance and Economics Discussion Series No. 045, Board of Governors of the Federal Reserve System (2017).Google Scholar
Yin, X.“A Comparison of Centralized and Fragmented Markets with Costly Search.” Journal of Finance, 60 (2005), 1567–1590.Google Scholar