Risk Sharing in Over-the-Counter Markets 1

I will begin with an overview of the purpose and structure of OTC markets, and how they can be a source of systemic risk.

This will be followed by a brief review of search-based theories of trade and information sharing in OTC markets. Then I will turn to theories and evidence regarding the use of collateral, the role of central clearing, and failure management. The failure management topic will finish with a model of the efficient application of legal stays that could be imposed on OTC contracts at the point of bankruptcy or administrative failure resolution. These stays can yield effective payment or settlement priority to OTC contracts. Stays can be efficient, or not efficient, depending on the setting. The affected OTC contracts include derivatives, repurchase agreements, securities lending agreements, and clearing agreements. I assume a basic knowledge of game theory and of measure-theoretic probability theory, particularly counting processes with an intensity.