Centralized clearing for over-the-counter derivatives
Purpose - 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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Volume (Year): 2 (2010)
Issue (Month): 4 (November)
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