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Clearing, transparency, and collateral

Listed author(s):
  • Francesco Carli

    (Universidade Catolica Portuguesa)

  • Francesca Carapella

    (Federal Reserve Board)

  • Gaetano Antinolfi

    (Washington University in Saint Louis)

In an environment of Over-The-Counter trading with adverse selection we study traders' incentives to screen their counterparties under different clearing arrangements. When the clearing arrangement is also a choice, traders decide which types of transactions to clear under each arrangement, with signicant consequences for transparency and collateral requirements. The key trade-off is between insurance and the value of information: on one hand risk averse traders want to smooth consumption and on the other hand they want to extract the largest feasible surplus from their counterparties. Choosing an arrangement that provides insurance, however, may prevent them from taking advantage of the private information they learn about their counterparty. In fact, any arrangement involving risk pooling in equilibrium is inconsistent with any costly screening. As a result, insurance comes at the cost of losing transparency: when clearing arrangements differ in the degree of risk sharing they implement, then they also differ in the degree of transparency arising in equilibrium. This has significant consequences on the role of collateral. In environ- ments with limited commitment, collateral plays two roles for risk averse traders: it is a means to discipline incentives and to self-insure at the same time. When insurance is provided by a clearing arrangement that imple- ments risk sharing, collateral is primarily used to discipline incentives, since risk sharing comes at the cost of less information about the limited commitment of the counterparty. The opposite is true in the equilibrium with a clearing arrangement that cannot provide risk sharing but gives traders sufficient incentives to screen their counterparties.

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File URL: https://economicdynamics.org/meetpapers/2014/paper_1090.pdf
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Paper provided by Society for Economic Dynamics in its series 2014 Meeting Papers with number 1090.

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Date of creation: 2014
Handle: RePEc:red:sed014:1090
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Acharya, Viral & Bisin, Alberto, 2014. "Counterparty risk externality: Centralized versus over-the-counter markets," Journal of Economic Theory, Elsevier, vol. 149(C), pages 153-182.
  2. Bech, Morten L. & Atalay, Enghin, 2010. "The topology of the federal funds market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 389(22), pages 5223-5246.
  3. David Mills & Francesca Carapella, 2012. "Information insensitive securities: the benefits of central counterparties," 2012 Meeting Papers 1032, Society for Economic Dynamics.
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