In the no-holds barred world of trading over-the-counter derivatives in the interbank market, traders and brokers view themselves as combatants in a professional market, where you lose one day, but can win the next... The industry is reluctant to fully automate OTC trading because it would result in a more open and transparent market and erode the informational advantages of the big dealers. Smaller banks have little choice but to abide by the rules.
MacKenzie (2012)
Abstract
We study frictions in trading patterns in the Euro money market. We characterize the structure of lending relations during the period of recent financial turmoil. We use a network-topology method on data from overnight transactions in the Electronic Market for Interbank Deposits (e-MID) to investigate two main issues. First, we characterize the roles of borrowers and lenders in long-run relationships by providing evidence on network formation at a 3-month frequency. Second, we identify the “key players” in the marketplace and study their behavior. In our formalization, key players are “locally-central banks” within a network that lend (or borrow) large volumes to (from) several counterparties, while borrowing (or lending) small volumes from (to) a small number of institutions. Our results are twofold. We show that the aggregate trading patterns in e-MID are characterized by largely asymmetric relations. This implies a clear difference in the roles of lenders and borrowers, with market positions changing only gradually over time. We also find that the large net lenders exploit their positions as network leaders by imposing aggressive pricing policies on their counterparties.
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Notes
Recent contributions focus on the systemic implications of funding risk, namely, the risk that a bank’s shortage of cash may spill over into the entire financial system (see, e.g., Drehmann and Tarashev 2011).
The role of market reputation is also stressed by Idier and Nardelli (2011) in the context of over-the-counter segments of the Euro interbank market.
The issue of market power in financial networks is also investigated by Kraenzlin and von Scarpatetti (2011), who study the price setting behavior in the Swiss Franc repo market during the turmoil period. They find that banks use both their market power and private information to offer different lending rates depending on the characteristics of their counterparties.
Iori et al. (2014) suggest that “preferential” trading is related to the “memory” of transactions. Hence, the more often a bank has lent to a counterparty, the more likely it is that it will lend again to that borrower.
Babus (2006) characterizes the information leading to network formation as information about counterparty risk, or “risk of contagion”. The author provides a theoretical model suggesting that banks minimize the tradeoff between the costs and benefits of creating a network by choosing partners resilient to contagion from adverse shocks. Thus, an equilibrium network has a contagion probability equal to zero. In addition, the banks outside the network face credit rationing from part of the network components.
Specifically, we are interested in identifying the market structure—i.e., discovering the existence of stable relationships among pairs or subgroups of banks, detecting the persistence of roles, and interpreting our results in light of the turmoil.
The net traded volume distribution is obtained as the difference between volumes lent and volumes borrowed per bank.
There are banks that join or leave the system at different points in time. Across the sample period, the total number of actors operating in e-MID is 194.
This choice is based on the assumptions that actors earn high profits by trading on the information they obtain through the network and that eigenvector centrality effectively captures access to information.
Ozsoylev and Walden (2009) suggest that this topological property holds for complex networks.
Note that the high values of market concentration support this proposition.
The correlations are computed for five values of \(\alpha \), within a range of \(\alpha = 0\) and \(\alpha = 1\).
Tensions in segments of the U.S.-dollar-denominated money markets reached their highest point on August 9, 2007. To stabilize market conditions, the ECB started a series of open-market operations supplying Euro-denominated cash.
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Acknowledgments
The authors acknowledge helpful comments from seminar participants at the Bank of Finland. They are also very grateful to Stefano Nardelli and to an anonymous referee for very insightful suggestions that led to major improvements of the paper. Tatjana Berg provided very valuable editorial assistance. Marzo and Zagaglia received financial support through a PRIN Grant by the Ministry of Education and Research at the University of Bologna.
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Liberati, C., Marzo, M., Zagaglia, P. et al. Drivers of demand and supply in the Euro interbank market: the role of “Key Players” during the recent turmoil. Financ Mark Portf Manag 29, 207–250 (2015). https://doi.org/10.1007/s11408-015-0251-7
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DOI: https://doi.org/10.1007/s11408-015-0251-7