How Competition and Transparency Affect OTC Derivatives Fees

Summary

The document explains how investment banks’ charges for derivatives relate to market competition and the transparency of pricing. It frames the added cost as a wider bid–ask spread rather than necessarily as a separate fee on top of a theoretical risk-neutral value. When few firms offer a product, dealers may be able to quote wider spreads and earn more; as competitors enter, pricing pressure can reduce those spreads.

The answer also notes that limited public visibility into over-the-counter derivative quotes makes it harder for customers and researchers to assess spreads than in markets with published prices and academic studies. It uses newly developed products as an example of instruments that may initially face little competition. The explanation is qualitative: it gives no pricing formula, empirical measurements, or method for estimating a fair spread, and actual costs will depend on the product and market conditions.

Key ideas

• Dealer costs on derivatives can be reflected in bid–ask spreads.
• Limited competition can allow wider spreads and greater dealer profitability.
• Newly introduced derivatives may face less competition until other firms offer them.
• Opaque OTC pricing makes spreads harder to observe and compare.

Tags

# Fees on derivatives


# Fees on derivatives












Since it's obviously not at their fair value that derivatives are priced, how do investment banks compute the fees that they add on top of the risk neutral price ?

## Answer by Alex C (score 3)

https://quant.stackexchange.com/a/25700

As with everything else it is determined by competition: little or no competition => very high fees (or more correctly large bid-ask spreads). That is one reason why many IB try to develop new derivatives: they can be very profitable when no one else trades them yet. Then the cost comes down somewhat when competitors come in. Lack of transparency in pricing also helps the IBs (have you ever seen prices of OTC derivatives listed in the Wall Street Journal or any public place? Or an academic study of bid ask spread for i.r. swaps like you can find for listed stocks? I haven't).

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.