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Full Description
Over-the-counter (OTC) markets for derivatives, collateralized debt obligations, and repurchase agreements played a significant role in the global financial crisis. Rather than being traded through a centralized institution such as a stock exchange, OTC trades are negotiated privately between market participants who may be unaware of prices that are currently available elsewhere in the market. In these relatively opaque markets, investors can be in the dark about the most attractive available terms and who might be offering them. This opaqueness exacerbated the financial crisis, as regulators and market participants were unable to quickly assess the risks and pricing of these instruments. Dark Markets offers a concise introduction to OTC markets by explaining key conceptual issues and modeling techniques, and by providing readers with a foundation for more advanced subjects in this field. Darrell Duffie covers the basic methods for modeling search and random matching in economies with many agents.
He gives an overview of asset pricing in OTC markets with symmetric and asymmetric information, showing how information percolates through these markets as investors encounter each other over time. This book also features appendixes containing methodologies supporting the more theory-oriented of the chapters, making this the most self-contained introduction to OTC markets available.
Contents
List of Tables ix List of Figures xi Preface xiii Chapter 1: Over-the-Counter Markets 1 1.1 Bilateral Negotiation of Terms 2 1.2 OTC Transparency 4 1.3 Why Trade Over the Counter? 6 1.4 Managing OTC Credit Risk 8 1.5 Price Behavior with Search Frictions 9 Chapter 2: The Case of Federal Funds Lending 13 2.1 T he Federal Funds Market 14 2.2 Data 17 2.3 A nalysis of Transaction-Pairing Likelihood 19 2.4 Determinants of the Rate 22 Chapter 3: Search for Counterparties 27 3.1 Preliminaries 27 3.2 R andom Matching 28 3.3 Dynamic Search Models 31 3.4 Markov Chain for Type 33 3.5 C ontinuous-Time Search and Matching 35 3.6 O ptimal Search 36 3.7 E quilibrium Search Intensities 39 3.8 Development of the Search Literature 40 Chapter 4: A Simple OTC Pricing Model 42 4.1 Basic Risk-Neutral OTC Pricing Model 42 4.2 Bargaining over the Price 46 4.3 R isk Aversion 49 4.4 N umerical Example 54 4.5 Price Response to Supply Shocks 56 4.6 N umerical Examples 59 Chapter 5: Information Percolation in OTC Markets 63 5.1 T he Basic Model 64 5.2 Population Information Dynamics 66 5.3 Market Settings 69 5.3.1 I nformation Sharing at Wallet Games 69 5.3.2 Double Auctions 70 5.4 N umerical Example 72 5.5 N ew Private Information 73 5.6 Multiagent Information Exchanges 74 5.7 V alid Initial Type Distributions 75 5.8 C onvergence and Further Extensions 76 Appendix: Foundations for Random Matching 79 A.1 Mathematical Preliminaries 79 A.2 R andom Matching Results 80 B: Counting Processes 84 Bibliography 87 Index 93
