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Intermediation and Asset Prices

Paper Session

Sunday, Jan. 5, 2020 10:15 AM - 12:15 PM (PDT)

Manchester Grand Hyatt, Harbor A
Hosted By: American Finance Association
  • Chair: Kathy Yuan, London School of Economics

The Coordination of Intermediation

Ming Yang
Duke University
Yao Zeng
University of Washington


We study liquidity provision by decentralized financial intermediaries (i.e., dealers) in a dynamic model of asset markets. When inventory cost is low (high), dealers provide more (less) liquidity by holding more (less) inventory, the market is liquid (illiquid), and interdealer trading is active (inactive). When inventory cost is medium, a dealer provides more liquidity if and only if other dealers do so, leading to strategic coordination motives and multiple equilibria. Switching between equilibria implies the potential for liquidity declines without fundamental shocks. A smaller trading friction among dealers effectively reduces inventory cost and hence reduces the possibility of multiple equilibria.

Financially Constrained Strategic Arbitrage

Aytek Malkhozov
Federal Reserve Board
Gyuri Venter
Copenhagen Business School


We develop an equilibrium model of strategic trading under …nancial constraints. Investors have access to a fundamentally riskless arbitrage opportunity, but may be forced to …re-sell if their capital does not fully cover their losses. Investors internalize both their price impact and the effect of price movements on the constraints of all market participants, giving rise to a strategic motive for the less exposed investors to induce …re-sales of more exposed ones. Ex ante, the presence of predatory risk leads to lower investment by all traders. We show the implications of strategic trading on price dynamics, returns characteristics, and leverage cross-section and dynamics.

Pitfalls of Central Clearing in the Presence of Systematic Risk

Christian Kubitza
University of Bonn
Loriana Pelizzon
Goethe University Frankfurt
Mila Getmansky Sherman
University of Massachusetts-Amherst


Through the lens of market participants' objective to minimize counterparty risk, we investigate
central clearing in derivatives markets, and its interaction with systematic risk, portfolio directionality, and loss sharing. Previous studies suggest that central clearing always reduces counterparty risk for a suffciently large number of clearing members. We show that this is not the case - mostly because of loss sharing. Central clearing can increase counterparty risk, particularly during extreme market events, for traders with directional portfolios, and because CCPs mutualize default losses. Our results are consistent with the reluctance to clear derivative trades in the absence of a clearing obligation.
Chong Huang
University of California-Irvine
Jungsuk Han
Stockholm School of Economics
Jessie Jiaxu Wang
Arizona State University
JEL Classifications
  • G1 - General Financial Markets