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Optimal Clearing Arrangements for Financial Trades

Listed author(s):
  • Thorsten Koeppl

    ()

    (Queen's University)

  • Cyril Monnet

    ()

    (Federal Reserve Bank of Philadelphia)

  • Ted Temzelides

    ()

    (Rice University)

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
File Function: First version 2009
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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
Handle: RePEc:qed:wpaper:1222
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  1. 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.
  2. Pierre-Olivier Weill & Dimitri Vayanos, 2005. "A Search-Based Theory of the On-the-Run Phenomenon," 2005 Meeting Papers 701, Society for Economic Dynamics.
  3. Antoine Martin & James J. McAndrews, 2008. "A study of competing designs for a liquidity-saving mechanism," Staff Reports 336, Federal Reserve Bank of New York.
  4. Charles M. Kahn & William Roberds, 1997. "Payment system settlement and bank incentives," Proceedings 537, Federal Reserve Bank of Chicago.
  5. Aiyagari, S. Rao & Williamson, Stephen, 1997. "Money and Dynamic Credit Arrangements with Private Information," Working Papers 97-19, University of Iowa, Department of Economics.
  6. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2005. "Over-the-Counter Markets," Econometrica, Econometric Society, vol. 73(6), pages 1815-1847, November.
  7. Charles M. Kahn & James J. McAndrews & William Roberds, 1999. "Settlement risk under gross and net settlement," Staff Reports 86, Federal Reserve Bank of New York.
  8. Koeppl, Thorsten Volker & Monnet, Cyril & Temzelides, Ted, 2006. "A dynamic model of settlement," Working Paper Series 0604, European Central Bank.
  9. Antoine Martin, 2002. "Optimal pricing of intra-day liquidity," Research Working Paper RWP 02-02, Federal Reserve Bank of Kansas City.
  10. Allen N. Berger & Diana Hancock & Jeffrey C. 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.
  11. Charles M. Kahn & William Roberds, 1999. "Real-time gross settlement and the costs of immediacy," FRB Atlanta Working Paper 98-21, Federal Reserve Bank of Atlanta.
  12. Enghin Atalay & Antoine Martin & James J. McAndrews, 2008. "The welfare effects of a liquidity-saving mechanism," Staff Reports 331, Federal Reserve Bank of New York.
  13. 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.
  14. Antoine Martin & James J. 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. 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.
  17. Antoine Martin & James J. McAndrews, 2008. "An economic analysis of liquidity-saving mechanisms," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 25-39.
  18. 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.
  19. Monnet, Cyril & Roberds, William, 2008. "Optimal pricing of payment services," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1428-1440, November.
  20. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-151.
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