Risk in the OTC market has three aspects to take into consideration. This includes issues related to dealer concentration, illiquidity as well as credit risks. However, in most of the cases, the risks are taken care of effectively. The article below reveals certain facts about the same.
Certain fears have been expressed as far as the OTC or Over-the -counter markets are concerned. These fears are pertaining to the risk in the OTC markets for United States dollar option rates.
It was ascertained that this would also impact the GSEs or the Government Sponsored Enterprises, non-banking derivatives.
The following risks have been identified:
Credit losses related to potential counter parties.
Market risks pertaining to dealers
Illiquidity in the options market
However, the graveness of the situation depends on the manner in which the participants of the market handle these risks. One of the main risks in the OTC markets is the concentration of dealers. Nevertheless, these risks are managed effectively.
Importance of the OTC or the Over-the-Counter markets:
The OTC market related to USD interest rate option plays an important role in living upto the demands of home mortgages with fixed rates of interest. Mortgage holders as well as the GSEs or the Government Sponsored Enterprises are in particular dependent on such instruments because they tend to avoid the prepayment risks.
In the event when an active dealer leaves the market, it may or may not impact the liquidity of the markets. However, it is a well-known fact that the GSEs strategies pertaining to risk management is dependent on liquidity, which is continuous in swap markets. The option markets are not banked upon to a large extent. Moreover, the dealer concentration is much less in the swap markets.
The market participants depend mainly on collaterals as a measure for minimizing credit losses pertaining to counter parties. In general, the participants of the market have been observed to deal with credit risks quite effectively.
Last Updated on : 1st August 2013