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Payments and Mechanism Design

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Author Info

  • Thor Koeppl

    ()
    (Queen's University)

  • Cyril Monnet

    ()
    (European Central Bank)

  • Ted Temzelides

    ()
    (University of Pittsburg)

Abstract

We use mechanism design to study efficient intertemporal payment arrangements when the ability of agents to perform certain welfare-improving transactions is subject to random and unobservable shocks. Efficiency is achieved via a payment system that assigns balances to participants, adjusts them based on the histories of transactions, and periodically resets them through settlement. Our analysis has several implications for the design of actual payment systems. Efficiency requires that, in order to overcome informational frictions, agents participating in transactions that do not involve monitoring frictions subsidize those that are subject to such frictions. Optimal settlement frequency should balance liquidity costs from settlement against the need to provide intertemporal incentives. Settlement costs must be borne by agents for whom the incentives to participate in the system are highest. Finally, an increase in settlement costs implies that, in order to counter a higher exposure to default, the frequency of settlement must increase and, at the same time, the volume of transactions must decrease.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1124.pdf
File Function: First version 2007
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Bibliographic Info

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1124.

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Length: 36 pages
Date of creation: Jan 2007
Date of revision:
Handle: RePEc:qed:wpaper:1124

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Related research

Keywords: Payment Systems; Frequency of Settlement; Liquidity Costs; Subsidization across Transactions;

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References

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  1. Charles M. Kahn & William Roberds, . "Payment System Settlement and Bank Incentives," Center for Financial Institutions Working Papers 97-32, Wharton School Center for Financial Institutions, University of Pennsylvania.
  2. Green, Edward J. & Porter, Robert H., 1982. "Noncooperative Collusion Under Imperfect Price Information," Working Papers 367, California Institute of Technology, Division of the Humanities and Social Sciences.
  3. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  4. 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.
  5. Guillaume Rocheteau & Randall Wright, 2004. "Money in search equilibrium, in competitive equilibrium, and in competitive search equilibrium," Working Paper 0405, Federal Reserve Bank of Cleveland.
  6. Charles M. Kahn & William Roberds, 1999. "Real-time gross settlement and the costs of immediacy," Working Paper 98-21, Federal Reserve Bank of Atlanta.
  7. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 599-617, October.
  8. Koeppl, Thorsten Volker & Monnet, Cyril & Temzelides, Ted, 2006. "A dynamic model of settlement," Working Paper Series 0604, European Central Bank.
  9. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  10. Hiroshi Fujiki & Edward J. Green & Akira Yamazaki, 1999. "Sharing the risk of settlement failure," Working Papers 594, Federal Reserve Bank of Minneapolis.
  11. Charles M. Kahn & William Roberds, 2002. "The economics of payment finality," Economic Review, Federal Reserve Bank of Atlanta, issue Q2, pages 1-12.
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