Dealer networks, client sophistication and pricing in OTC derivatives

Using a novel regulatory transaction-level dataset, we analyze determinants of pricing in both dealer-to-dealer (D2D) and dealer-to-client (D2C) segments of over-the-counter (OTC) currency derivatives market enabling us to provide new empirical insights into frictions driving pricing in both segments separately and interplay of these frictions jointly. The interdealer network exhibits a core-periphery structure with core dealers charging centrality premia in both D2D and D2C segments. By acting as principal and prearranging fewer trades, they provide execution immediacy besides receiving the opportunity to internalize flows. In D2C segment, sophisticated clients experience a reduction in centrality premium alluding to an interplay of client bargaining power and dealer centrality in pricing.

Automated summary

Using a new regulatory transaction-level dataset, this study analyzes the determinants of pricing in the over-the-counter currency derivatives market for both dealer-to-dealer and dealer-to-client segments. The results show that there is a core-periphery structure in the interdealer network, with core dealers charging centrality premia in both segments. In the dealer-to-client segment, experienced clients experience a reduction in centrality premium, indicating an interplay between client bargaining power and dealer centrality in pricing.