Counterparty Risk Externality: Centralized Versus Over-the-Counter Markets

@article{Acharya2014CounterpartyRE,
  title={Counterparty Risk Externality: Centralized Versus Over-the-Counter Markets},
  author={Viral Acharya and Alberto Bisin},
  journal={Microeconomics: Production},
  year={2014}
}
We model the opacity of over-the-counter (OTC) markets in a setup where agents share risks, but have incentives to default and their financial positions are not mutually observable. We show that this setup results in excess "leverage" in that parties take on short OTC positions that lead to levels of default risk that are higher than Pareto-efficient ones. In particular, OTC markets feature a "counterparty risk externality" that we show can lead to ex-ante productive inefficiency. This… 
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