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The Venezuelan Overnight Fund Market: Understanding a Credit Constraint Limit Order Market

Pagliacci, Carolina (2006): The Venezuelan Overnight Fund Market: Understanding a Credit Constraint Limit Order Market.

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Abstract

The Venezuelan overnight market trades funds electronically similarly to limit order markets, but allows the imposition of credit lines, which inflict binding credit restrictions to some participants and introduce a peculiar bid-ask spread dynamic. The objective of this paper is to determine whether the trading costs exhibited in this market can be explained by credit constraints, and other particular market features such as, the degree of collateralized trades and the flow of government payments into the financial system. Econometrically, we test this hypothesis using a definition of effective spread that takes into account the special microstructure of the market, and measuring credit constraints throughout two different observable expressions. We carry out the empirical study estimating single equation GARCH models on the effective spread and on other two broader measures of market performance extracted from the application of principal component analysis. Results indicate that distortions associated to credit constraints are important, and there is room for policy prescriptions that promote the elimination of credit lines.

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