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Dark Markets by Darrell Duffie

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CHAPTER 2

The Case of Federal Funds Lending

This chapter1 shows how the intraday allocation and pricing of overnight loans of federal funds reflect the OTC interbank market in which these loans are traded. A would-be borrower or lender typically finds a counterparty institution by direct bilateral contact. Once in contact, say by telephone, the two counterparties to a potential trade negotiate terms that reflect their incentives for borrowing or lending, as well as the attractiveness of their respective options to forego a trade and to continue “shopping around.” This OTC pricing and allocation mechanism is quite distinct from that of most centralized markets, such as an electronic limit-order-book market in which every order is anonymously exposed ...

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