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The Efficiency of Central Clearing: A Segmented Markets Approach

Author

Listed:
  • James Hansen

    (Reserve Bank of Australia)

  • Angus Moore

    (Reserve Bank of Australia)

Abstract

This paper examines the role of central clearing in a consumption-based asset pricing model with incomplete markets and default. We show that central clearing can increase welfare by insuring against counterparty credit risk when private insurance markets are incomplete. We find that the gains from central clearing are largest when there is a higher probability of default and when over-the-counter derivative contracts provide an effective hedge against underlying risk. However, the potential gains are sensitive to the level of margin required by the central counterparty. When margin requirements are not set optimally, central clearing can result in too much or too little financial trade.

Suggested Citation

  • James Hansen & Angus Moore, 2016. "The Efficiency of Central Clearing: A Segmented Markets Approach," RBA Research Discussion Papers rdp2016-07, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp2016-07
    as

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    File URL: https://www.rba.gov.au/publications/rdp/2016/pdf/rdp2016-07.pdf
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    References listed on IDEAS

    as
    1. Heath, Alexandra & Kelly, Gerard & Manning, Mark & Markose, Sheri & Shaghaghi, Ali Rais, 2016. "CCPs and network stability in OTC derivatives markets," Journal of Financial Stability, Elsevier, vol. 27(C), pages 217-233.
    2. Daniel Heller & Nicholas Vause, 2012. "Collateral requirements for mandatory central clearing of over-the-counter derivatives," BIS Working Papers 373, Bank for International Settlements.
    3. Koeppl, Thorsten & Monnet, Cyril & Temzelides, Ted, 2012. "Optimal clearing arrangements for financial trades," Journal of Financial Economics, Elsevier, vol. 103(1), pages 189-203.
    4. Matt Gibson, 2013. "Recovery and Resolution of Central Counterparties," RBA Bulletin (Print copy discontinued), Reserve Bank of Australia, pages 39-48, December.
    5. Stacey Anderson & Jean-Philippe Dion & Héctor Pérez Saiz, 2013. "To Link or Not To Link? Netting and Exposures Between Central Counterparties," Staff Working Papers 13-6, Bank of Canada.
    6. John P Jackson & Mark J Manning, 2007. "Comparing the pre-settlement risk implications of alternative clearing arrangements," Bank of England working papers 321, Bank of England.
    7. Alexandra Heath & Gerard Kelly & Mark Manning, 2015. "Central Counterparty Loss Allocation and Transmission of Financial Stress," RBA Research Discussion Papers rdp2015-02, Reserve Bank of Australia.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Massimiliano Affinito & Matteo Piazza, 2021. "Always Look on the Bright Side? Central Counterparties and Interbank Markets during the Financial Crisis," International Journal of Central Banking, International Journal of Central Banking, vol. 17(1), pages 231-283, March.

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    More about this item

    Keywords

    central counterparties; central clearing; over-the-counter derivatives; mutualisation externality; collateral; margin requirements; moral hazard;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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