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Optimal clearing arrangements for financial trades

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Author Info

  • Koeppl, Thorsten
  • Monnet, Cyril
  • Temzelides, Ted

Abstract

Clearinghouses support financial trades by keeping records of transactions and by providing liquidity through short-term credit that participants clear periodically. We study efficient clearing arrangements for exchanges, where traders must clear with a clearinghouse, and for over-the-counter (OTC) markets, where traders can clear bilaterally. When clearing is costly, it can be efficient to subsidize OTC clearing by charging a higher clearing price for transactions conducted on exchanges. The clearinghouse then operates across both markets. Since clearinghouses offer credit, intertemporal incentives are needed to ensure settlement. When liquidity costs increase, concerns about default lead to a tightening of liquidity provision.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 103 (2012)
Issue (Month): 1 ()
Pages: 189-203

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Handle: RePEc:eee:jfinec:v:103:y:2012:i:1:p:189-203

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Web page: http://www.elsevier.com/locate/inca/505576

Related research

Keywords: Clearing; OTC vs. exchanges; Private information; Liquidity costs; Default;

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References

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  1. Jamie McAndrews & Antoine Martin, 2007. "Liquidity saving mechanisms," 2007 Meeting Papers 165, Society for Economic Dynamics.
  2. Duffie, Darrell & Garleanu, Nicolae Bogdan & Pedersen, Lasse Heje, 2006. "Valuation in Over-the-Counter Markets," CEPR Discussion Papers 5491, C.E.P.R. Discussion Papers.
  3. Kahn, Charles M & Roberds, William, 1998. "Payment System Settlement and Bank Incentives," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 845-70.
  4. Charles M. Kahn & James McAndrews & William Roberds, 1999. "Settlement risk under gross and net settlement," Working Paper 99-10, Federal Reserve Bank of Atlanta.
  5. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2004. "Over-the-Counter Markets," NBER Working Papers 10816, National Bureau of Economic Research, Inc.
  6. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-51.
  7. Aiyagari, S. Rao & Williamson, Stephen D., 2000. "Money and Dynamic Credit Arrangements with Private Information," Journal of Economic Theory, Elsevier, vol. 91(2), pages 248-279, April.
  8. Michael J. Fleming & Kenneth D. Garbade, 2002. "When the back office moved to the front burner: settlement fails in the treasury market after 9/11," Economic Policy Review, Federal Reserve Bank of New York, issue Nov, pages 35-57.
  9. Allen Berger & Diana Hancock & Jeffrey Marquardt, 1996. "A framework for analyzing efficiency, risks, costs and innovations in the payments system," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 696-732.
  10. Hiroshi Fujiki & Edward J. Green & Akira Yamazaki, 1999. "Sharing the risk of settlement failure," Working Papers 594, Federal Reserve Bank of Minneapolis.
  11. Temzelides, Ted & Williamson, Stephen D., 2001. "Payments Systems Design in Deterministic and Private Information Environments," Journal of Economic Theory, Elsevier, vol. 99(1-2), pages 297-326, July.
  12. Antoine Martin, 2002. "Optimal pricing of intra-day liquidity," Research Working Paper RWP 02-02, Federal Reserve Bank of Kansas City.
  13. Thorsten Koeppl & Cyril Monnet & Ted Temzelides, 2006. "A Dynamic Model of Settlement," Working Papers 1053, Queen's University, Department of Economics.
  14. Charles M. Kahn & William Roberds, 1999. "Real-time gross settlement and the costs of immediacy," Working Paper 98-21, Federal Reserve Bank of Atlanta.
  15. Monnet, Cyril & Roberds, William, 2008. "Optimal pricing of payment services," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1428-1440, November.
  16. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
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Citations

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Cited by:
  1. Bruno Biais & Florian Heider & Marie Hoerova, 2012. "Clearing, Counterparty Risk, and Aggregate Risk," IMF Economic Review, Palgrave Macmillan, vol. 60(2), pages 193-222, July.
  2. Jorge Cruz Lopez & Jeffrey Harris & Christophe Hurlin & Christophe Pérignon, 2014. "CoMargin," Working Papers halshs-00979440, HAL.
  3. De Kamps, Marc & Ladley, Daniel & Simaitis, Aistis, 2014. "Heterogeneous beliefs in over-the-counter markets," Journal of Economic Dynamics and Control, Elsevier, vol. 41(C), pages 50-68.
  4. Degryse, Hans & Van Achter, Mark & Wuyts, Gunther, 2012. "Internalization, Clearing and Settlement, and Liquidity," CEPR Discussion Papers 8765, C.E.P.R. Discussion Papers.
  5. Thorsten V. Koeppl, 2013. "The Limits of Central Counterparty Clearing: Collusive Moral Hazard and Market Liquidity," Working Papers 1312, Queen's University, Department of Economics.
  6. Borghan Nezami Narajabad & Cyril Monnet, 2012. "Why Rent When You Can Buy? A Theory of Repurchase Agreements," 2012 Meeting Papers 647, Society for Economic Dynamics.

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