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Optimal Bidder Selection in Clearing House Default Auctions

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Abstract

Central counterparties' ability to hold successful default auctions is critically important to financial stability. However, due to the unique features of these auctions, standard auction theory results do not apply. We present a model of CCP default auctions that incorporates both the vital, but non-standard, objective of minimizing the likelihood it suffers reputationally damaging losses and the potential for information leakage to affect CCP members' private portfolio valuations. This gives insight into the key question of how CCPs should select auction participants. In particular, we prove that an entry fee, by appropriately incentivizing some members not to enter the auction, can maximize the probability of auction success. The result is novel, both in auction theory and as a mechanism for CCP auction design.

Suggested Citation

  • Rodney Garratt & David Murphy & Travis D. Nesmith & Xiaopeng Wu, 2023. "Optimal Bidder Selection in Clearing House Default Auctions," Finance and Economics Discussion Series 2023-033r1, Board of Governors of the Federal Reserve System (U.S.), revised 01 Aug 2024.
    • Handle: RePEc:fip:fedgfe:2023-33
    DOI: 10.17016/FEDS.2023.033r1
    Note: Revision
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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