Dealer inventory, pricing, and liquidity in the OTC derivatives markets: Evidence from index CDSs

• Published in: Journal of financial markets (Amsterdam, Netherlands) Netherlands), 2022-01, Vol.57, p.100617, Article 100617
• Main Authors: Wang, Xinjie, Zhong, Zhaodong (Ken)
• Format: Article
• Language: English
• Subjects: Credit default swap; Dealer inventory; Index basis; Intermediary asset pricing
• ISSN: 1386-4181; 1878-576X
• DOI: 10.1016/j.finmar.2020.100617

We examine the effects of dealers’ inventories on the pricing and liquidity of OTC derivatives markets. Using position and pricing data on credit default swap (CDS) indices, we document that the change in index CDS spreads is negatively associated with the change in dealers’ net long positions. The effect of dealer inventory on CDS spreads is stronger after the Volcker Rule is implemented in the United States. Furthermore, the divergence between index CDS spreads and their theoretical values (index basis) is also negatively associated with dealers’ net long positions. Finally, bid-ask spreads and the number of dealers increase when the inventory position of dealers is larger. •The change in index CDS spreads is negatively associated with the change in dealers’ net long positions. .•The effect of inventory on CDS spreads is stronger after the Volcker Rule is implemented. .•The index basis is also negatively associated with dealers’ net long positions. .•Bid-ask spreads and the number of dealers increase when dealers’ inventory position is larger. .•Our findings highlight the role of dealers in the pricing and liquidity of index CDSs and other swap contracts.