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Centralized clearing for over-the-counter derivatives

Author

Listed:
  • Gordon Rausser
  • William Balson
  • Reid Stevens

Abstract

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.

Suggested Citation

  • Gordon Rausser & William Balson & Reid Stevens, 2010. "Centralized clearing for over-the-counter derivatives," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 2(4), pages 346-359, November.
  • Handle: RePEc:eme:jfeppp:v:2:y:2010:i:4:p:346-359
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    References listed on IDEAS

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    1. Hart, Oliver D & Moore, John, 1988. "Incomplete Contracts and Renegotiation," Econometrica, Econometric Society, vol. 56(4), pages 755-785, July.
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    8. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    9. 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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    11. 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.
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    Cited by:

    1. Karel Janda & Gordon Rausser, 2011. "Comparing American and European Regulation of Over-the- Counter Derivative Securities," European Financial and Accounting Journal, University of Economics, Prague, vol. 2011(4), pages 7-19.
    2. Jean-Sébastien Fontaine & Héctor Pérez Saiz & Joshua Slive, 2012. "When Lower Risk Increases Profit: Competition and Control of a Central Counterparty," Staff Working Papers 12-35, Bank of Canada.

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