Abstract:The Dodd-Frank Act mandates that certain standard OTC derivatives be traded on swap execution facilities (SEF). This paper provides a granular analysis of SEF trading mechanisms, using message-level data for May 2016 from the two largest customer-to-dealer SEFs in index CDS markets. Both SEFs offer customers various execution mechanisms that differ in how widely customers’ trading interests are exposed to dealers. A theoretical model shows that although exposing the order to more dealers increases competition, it also causes a more severe winner’s curse. Consistent with this trade-off, the data show that customers contact fewer dealers if the trade size is larger or nonstandard. Dealers are more likely to respond to customers’ inquiries if fewer dealers are involved in competition, if the notional size is larger, or if more dealers are making markets. Finally, dealers’ quoted spreads and customers’ transaction costs increase in notional quantity and the number of dealers involved. Our results contribute to the understanding of swaps markets by providing insights into investors’ and dealers’ revealed preferences and strategic behaviors.
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