Макарян Нарек Арманович
The Volker Rule: Imposing Limitations on Proprietary Trading as an Inefficient Way of Eliminating Excessive Investment Risk
The Volcker Rule - a section of the Dodd-Frank Wall Street Reform and Consumer Protection Act - restricts commercial banks from trading securities for their own accounts and limits their ability to affiliate with hedge funds and private equity firms. The rule is intended to limit risk in the financial system by restricting institutions that are supported by public from taking on risk that may ultimately be borne by taxpayers. Using TRACE Historic Corporate Bond Data Set, I tested whether restrictions on inventory period and size which could follow from the proposal (required trade limits based on Reasonably Expected Near Term Demand of customers) will lead to substantial liquidity risks. The results suggest that the rule is unlikely to limit risk in the expected way, probably because it attempts to bypass, rather than address, a fundamental source of risk. As the theoretical analysis conducted suggests, even if it does successfully limit excessive risk taking, it will do so in a way harmful to transactional efficiency of markets and may lead to distortions in competition between dealers and cause redistribution of wealth.