Tarik Roukny (UGent)

Title: Compressing Over-the-counter Markets

Abstract: In this talk, we show both theoretically and empirically that the size of over-the-counter (OTC) markets can be reduced without affecting individual net positions. First, we find that the networked nature of these markets generates an excess of notional obligations between the aggregate gross amount and the minimum amount required to satisfy each individual net position. Second, we show conditions under which such excess can be removed while preserving individual net positions. We refer to this operation as compression and identify feasibility and efficiency criteria, highlighting intermediation as the key element for excess levels. We show that a trade-off exists between the amount of notional that can be removed from the system and the conservation of trading relationships. Third, we apply our theoretical framework to a unique and comprehensive transaction-level dataset on OTC derivatives. We document large levels of excess across all markets and time. Finally, we show that compression – when applied at a global level  – can reduce a considerable fraction of total notional even under relationship constrained approaches.