Abstracts

Bilateral bargaining in over-the-counter markets concerns the selection of contract terms and the pricing of contracts in settings involving a network of market participants. Of concern is whether bilateral contracting achieves efficiency in this multilateral setting. For example, will market participants efficiently assign termination and collateral rights, or should bankruptcy laws override contractual terms with an automatic stay at default? We provide conditions under which bilateral bargaining over contingent contracts is efficient for a network of market participants. Given the ability to use covenants and other contingent contract terms, central market participants such as dealers efficiently internalize the costs and benefits of their counterparties through the pricing of contracts.