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Optimal Clearing Arrangements for Financial Trades

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Author Info

  • Thorsten Koeppl

    ()
    (Queen's University)

  • Cyril Monnet

    ()
    (Federal Reserve Bank of Philadelphia)

  • Ted Temzelides

    ()
    (Rice University)

Abstract

Clearinghouses support financial trades by keeping records of transactions and by providing liquidity through short-term credit that is periodically cleared by participants. We study efficient clearing arrangements for formal exchanges, where traders must clear with a clearinghouse, and for over-the-counter (OTC) markets, where trades can be cleared bilaterally. When clearing is costly, we show that it can be efficient to subsidize the clearing process for OTC transactions by charging a higher price for the clearing of transactions in exchanges. This necessitates a clearinghouse that operates across both markets. As a clearinghouse offers credit, intertemporal incentives are needed in order to ensure settlement. An increase in the costs of liquidity provision worsens the incentives to settle. Hence, when liquidity costs increase, concerns about default must lead to a tightening of liquidity provision.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1222.pdf
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Bibliographic Info

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1222.

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Length: 41 pages
Date of creation: Nov 2009
Date of revision:
Handle: RePEc:qed:wpaper:1222

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Keywords: Clearing; OTC vs Exchanges; Private Information; Liquidity Costs; Default;

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References

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  1. 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.
  2. Aiyagari, S. Rao & Williamson, Stephen, 1997. "Money and Dynamic Credit Arrangements with Private Information," Working Papers 97-19, University of Iowa, Department of Economics.
  3. Charles M. Kahn & William Roberds, 1996. "Payment system settlement and bank incentives," Working Paper 96-10, Federal Reserve Bank of Atlanta.
  4. Kahn, Charles M & McAndrews, James & Roberds, William, 2003. " Settlement Risk under Gross and Net Settlement," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(4), pages 591-608, August.
  5. Antoine Martin, 2002. "Optimal pricing of intra-day liquidity," Research Working Paper RWP 02-02, Federal Reserve Bank of Kansas City.
  6. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2004. "Over-the-Counter Markets," NBER Working Papers 10816, National Bureau of Economic Research, Inc.
  7. Koeppl, Thorsten Volker & Monnet, Cyril & Temzelides, Ted, 2006. "A dynamic model of settlement," Working Paper Series 0604, European Central Bank.
  8. 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.
  9. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-51.
  10. Charles M. Kahn & William Roberds, 1999. "Real-time gross settlement and the costs of immediacy," Working Paper 98-21, Federal Reserve Bank of Atlanta.
  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. 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.
  13. 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.
  14. Antoine Martin & James McAndrews, 2007. "Liquidity-saving mechanisms," Staff Reports 282, Federal Reserve Bank of New York.
  15. Hiroshi Fujiki & Edward J. Green & Akira Yamazaki, 1999. "Sharing the risk of settlement failure," Working Papers 594, Federal Reserve Bank of Minneapolis.
  16. Monnet, Cyril & Roberds, William, 2008. "Optimal pricing of payment services," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1428-1440, November.
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Cited by:
  1. Degryse, H.A. & Achter, M. van & Wuyts, G., 2012. "Internalization, Clearing and Settlement, and Liquidity," Discussion Paper 2012-002, Tilburg University, Center for Economic Research.
  2. 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.
  3. 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.
  4. 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.
  5. Marc de Kamps & Daniel Ladley & Aistis Simaitis, 2012. "Heterogeneous Beliefs in Over-The-Counter Markets," Discussion Papers in Economics 13/03, Department of Economics, University of Leicester, revised Sep 2013.

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