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Centralized clearing for over-the-counter derivatives

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Author Info

  • Gordon Rausser
  • William Balson
  • Reid Stevens

Abstract

urpose – Systemic risk propagated through over-the-counter (OTC) derivatives can best be managed by a public-private central counterparty clearing house. The purpose of this paper is to outline the market microstructure necessary for such a clearing house. Design/methodology/approach – The paper proposes using an request for quote platform with an active permissioning system that uses analytic approximations based on Monte Carlo simulation to estimate default risk and a two-part pricing scheme to efficiently price that risk. Findings – It is found that comprehensive clearing for complex and standardized derivatives is feasible using the clearing framework. Research limitations/implications – This research is limited by the authors' ability to give empirical examples. The paper gives a short example with data, but given the constraints on length, cannot go into more detail. Practical implications – This comprehensive clearing structure, in contrast to current proposed government regulations, will not drive out the “good” with the “bad” OTC derivative instruments. Originality/value – This is the only paper the authors are aware of that outlines a detailed framework for clearing all OTC derivatives.

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Bibliographic Info

Article provided by Emerald Group Publishing in its journal Journal of Financial Economic Policy.

Volume (Year): 2 (2010)
Issue (Month): 4 (December)
Pages: 346-359

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Handle: RePEc:eme:jfeppp:v:2:y:2010:i:4:p:346-359

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Web page: http://www.emeraldinsight.com

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Related research

Keywords: Derivative markets; Financial risk; Legislation; Risk management; United States of America;

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References

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  1. Oliver Hart & John Moore, 1985. "Incomplete Contracts and Renegotiation," Working papers 367, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," Harvard Institute of Economic Research Working Papers 1846, Harvard - Institute of Economic Research.
  3. Timothy Besley & Maitreesh Ghatak, 2001. "Government Versus Private Ownership Of Public Goods," The Quarterly Journal of Economics, MIT Press, vol. 116(4), pages 1343-1372, November.
  4. Pratt, John W & Zeckhauser, Richard J, 1989. " The Impact of Risk Sharing on Efficient Decision," Journal of Risk and Uncertainty, Springer, vol. 2(3), pages 219-34, September.
  5. Oliver Hart & Sanford Grossman, 1985. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Working papers 372, Massachusetts Institute of Technology (MIT), Department of Economics.
  6. Francesconi, Marco & Muthoo, Abhinay, 2006. "Control Rights in Public-Private Partnerships," CEPR Discussion Papers 5733, C.E.P.R. Discussion Papers.
  7. Mario J. Miranda & Paul L. Fackler, 2004. "Applied Computational Economics and Finance," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262633094.
  8. Gregory, Allan W. & Reeves, Jonathan J., 2008. "Interpreting Value at Risk (VaR) forecasts," Economic Systems, Elsevier, vol. 32(2), pages 167-176, June.
  9. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  10. Williams, Jeffrey C., 2001. "Commodity futures and options," Handbook of Agricultural Economics, in: B. L. Gardner & G. C. Rausser (ed.), Handbook of Agricultural Economics, edition 1, volume 1, chapter 13, pages 745-816 Elsevier.
  11. Arnold M. Faden & Gordon C. Rausser, 1976. "Econometric Policy Model Construction: The Post-Bayesian Approach," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 5, number 3, pages 349-363 National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Jean-Sébastien Fontaine & Héctor Pérez Saiz & Joshua Slive, 2012. "When Lower Risk Increases Profit: Competition and Control of a Central Counterparty," Working Papers 12-35, Bank of Canada.

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