Opportunity cost and prudentiality : an analysis of futures clearinghouse behavior
Margin deposits, which serve as collateral to protect the clearinghouse, are typically the most important tool for risk management. The authors develop a model that explains how creating a futures clearinghouse may allow traders simultaneously to reduce both the risk of default and the total amount of margin that members post. Optimal margin levels are determined by the need to balance the deadweight costs of default against the opportunity cost of holding additional margin. Both costs are a consequence of market participants'imperfect access to capital markets. The simultaneous reduction in default risk and in the opportunity cost of margin deposits is possible because the creation of the clearinghouse facilitates multilateral netting. The authors characterize the conditions under which multilateral netting will dominate bilateral netting. They also show that it is credible for the clearinghouse to expel members who default, further reducing the risk of default. Finally, they show that it may (but need not) be optimal for the clearinghouse to monitor the financial condition of its members. If monitoring occurs, it will reduce the amount of margin required, but need not affect the probability of default. The empirical tests run by the authors indicate that the opportunity cost of margin plays an important role in determining margin. The relationship between volatility and margins indicates that participants face an upward-sloping opportunity cost for margin, which appears to more than offset the effects that monitoring and expulsion would be expected to have on margin setting.
|Date of creation:||31 Aug 1994|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: (202) 477-1234
Web page: http://www.worldbank.org/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Herbert L. Baer & Virginia G. France & James T. Moser, 1993. "Opportunity cost and prudentiality: a representative-agent model of futures clearinghouse behavior," Working Paper Series, Issues in Financial Regulation 93-18, Federal Reserve Bank of Chicago.
- Barone-Adesi, Giovanni & Whaley, Robert E, 1987. " Efficient Analytic Approximation of American Option Values," Journal of Finance, American Finance Association, vol. 42(2), pages 301-20, June.
- Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 5-59.
- Craine, Roger, 1992. "Are Futures Margins Adequate?," Department of Economics, Working Paper Series qt30c296g3, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
- Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
- Steven M. Fazzari & R. Glenn Hubbard & BRUCE C. PETERSEN, 1988.
"Financing Constraints and Corporate Investment,"
Brookings Papers on Economic Activity,
Economic Studies Program, The Brookings Institution, vol. 19(1), pages 141-206.
- Calomiris, Charles W & Hubbard, R Glenn, 1995. "Internal Finance and Investment: Evidence from the Undistributed Profits Tax of 1936-37," The Journal of Business, University of Chicago Press, vol. 68(4), pages 443-82, October.
When requesting a correction, please mention this item's handle: RePEc:wbk:wbrwps:1340. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Roula I. Yazigi)
If references are entirely missing, you can add them using this form.