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Centralized clearing for over-the-counter derivatives

  • Gordon Rausser
  • William Balson
  • Reid Stevens

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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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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  1. Besley, Timothy J. & Ghatak, Maitreesh, 2001. "Government versus Private Ownership of Public Goods," CEPR Discussion Papers 2725, C.E.P.R. Discussion Papers.
  2. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," Harvard Institute of Economic Research Working Papers 1846, Harvard - Institute of Economic Research.
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  4. Gregory, Allan W. & Reeves, Jonathan J., 2008. "Interpreting Value at Risk (VaR) forecasts," Economic Systems, Elsevier, vol. 32(2), pages 167-176, June.
  5. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  6. Marco Francesconi & Abhinay Muthoo, 2006. "Control Rights in Public-Private Partnership," Economics Discussion Papers 612, University of Essex, Department of Economics.
  7. Oliver Hart & John Moore, 1985. "Incomplete Contracts and Renegotiation," Working papers 367, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  9. 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.
  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. Mario J. Miranda & Paul L. Fackler, 2004. "Applied Computational Economics and Finance," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262633094, June.
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