Yield to Commission

Abstract

The principle of maximizing the “yield to commission” is a normal human trait and one that applies to sales in just about any industry. In the over-the-counter (OTC) world of complex assets containing subprime debt, however, everybody besides the dealers seems to be the losers. OTC instruments offer dealers far better profits than exchange-traded contracts, but at a cost in terms of inferior price discovery, a lack of liquidity support from other dealers, and little or no secondary market support for buy side investors. The use of illiquid and opaque OTC instruments not only was an important factor in the failures of Long Term Capital Management, Amaranth Advisers, and Bear Stearns, but also threatened the stability of other firms and in general caused substantial market volatility, both for OTC markets and the traditional exchanges. The author observes that there is a substantial “silent majority” of investors, advisers, and risk professionals who would be very pleased to see much of the OTC market flows in derivatives and structured assets move back into the daylight of open price discovery and liquidity that an exchange-based model provides.