Does OTC derivatives reform incentivize central clearing?

Regulatory changes in the over-the-counter (OTC) derivatives market seek to reduce systemic risk. The reforms require that standardized derivatives be cleared through central counterparties (CCPs), and they set higher capital and margin requirements for non-centrally cleared derivatives. We investigate whether these requirements create a cost incentive in favor of central clearing, as intended. We compare the total capital and collateral costs when banks transact fully bilaterally and when they clear all contracts through CCPs. We calibrate our model using data on the OTC market collected by the Federal Reserve. We find that the cost incentive may not favor central clearing. The main factors driving the cost comparison are netting benefits, the margin period of risk, and CCP guarantee fund requirements. Lower guarantee fund requirements lower the cost of clearing but make CCPs less resilient.     

CCPs and network stability in OTC derivatives markets

Among the reforms to OTC derivative markets since the global financial crisis is a commitment to collateralize counterparty exposures and to clear standardized contracts via central counterparties (CCPs). The reforms aim to reduce interconnectedness and improve counterparty risk management in these important markets. At the same time, however, the reforms necessarily concentrate risk in one or a few nodes in the financial network and also increase institutions’ demand for high-quality assets to meet collateral requirements. This paper looks more closely at the implications of increased CCP clearing for both the topology and stability of the financial network. Building on Heath et al. (2013) and Markose (2012), the analysis supports the view that the concentration of risk in CCPs could generate instability if not appropriately managed. Nevertheless, maintaining CCP prefunded financial resources in accordance with international standards and dispersing any unfunded losses widely through the system can limit the potential for a CCP to transmit stress even in very extreme market conditions. The analysis uses the Bank for International Settlements Macroeconomic Assessment Group on Derivatives (MAGD) data set on the derivatives positions of the 41 largest bank participants in global OTC derivative markets in 2012.     

中央对手方清算国际监管的改革与发展

针对场外衍生品市场在本次国际金融危机中所暴露出的风险和问题,国际社会进行了广泛而深入的探讨,对尽快在场外衍生品市场引入CCP清算机制达成共识。文章以美国、欧盟和国际组织为主要考察对象,回顾了国际上实施CCP清算和对CCP监管改革的进展情况,从对CCP风险管理、财务资源监管、信息披露监管和利益冲突监管等方面对CCP具体监管要求进行了阐释和比较,以全面反映CCP清算国际监管改革的发展历程与政策要点。     

Counterparty risk,central counterparty clearing and aggregate risk

I construct a model of bilateral trading of over-the-counter (OTC) derivatives to study the performance of central counterparty (CCP) clearing. I first show how buyers are exposed to counterparty risk under bilateral clearing. I then show how a CCP can fully insure against counterparty risk through risk-mutualization and achieve full idiosyncratic risk-sharing among market participants. I further demonstrate the impact of aggregate risk on CCP clearing and illustrate a scenario in which the CCP fails to provide full insurance against counterparty risk and full idiosyncratic risk-sharing collapses under severe aggregate risk. To insure against aggregate risk and retain full idiosyncratic risk-sharing, sellers’ capital resource is important on top of CCP mutualization. Finally, I allow buyers to costly search for sellers and study the implications of optimal search effort. I show how a moral hazard problem can arise if effort is unobservable, in which case full CCP insurance against counterparty risk is no longer optimal.     

Mitigating fire sales with a central clearing counterparty

Theoretically, one rationale for central clearing counterparties is the mitigation of inefficiencies associated with distressed asset sales. With novel archival data, I empirically study the first event in economic history during which a CCP successfully played this role: the global wool crisis of 1900. In the leading wool futures market in France, an inefficient equilibrium with fire sales and cascading defaults could be avoided due to price support provided by surviving CCP members. Cooperation to achieve price support–which is nowadays the main element of CCP auctions–could arise due to family relationships and cultural proximity between traders.     

Risk‐based explanation for the book‐to‐market effect

This paper proposes a risk‐based explanation for the book‐to‐market (B/M) effect. I decompose B/M into net operating asset‐to‐market (NOA/M) and net financing asset‐to‐market (NFA/M) components. Portfolio analysis shows that (i) positive B/M, NOA/M and NFA/M are positively related to future returns and (ii) negative B/M, NOA/M and NFA/M are negatively related to future returns. To the extent that positive B/M, NOA/M and NFA/M act as measures of asset risk and negative B/M, NOA/M and NFA/M act as inverse measures of borrowing risk, the nonlinear relations between B/M, NOA/M and NFA/M and future returns provide some evidence to support the risk‐based explanation for the book‐to‐market effect in stock returns.     

Improving Overnight Loan Identification in Payments Systems

Information on the allocation and pricing of over‐the‐counter (OTC) markets is scarce. Furfine (1999) pioneered an algorithm that provides transaction‐level data on the OTC interbank lending market. The veracity of the data identified, however, is not well established. Using permutation methods, I estimate an upper bound on the daily false positive rate of this algorithm to be between 10% and 20%. I propose refinements that reduce the bound to 10% or lower with negligible power loss. The results suggest that the inferred prices and quantities of overnight loans provide viable estimates of interbank lending market activity for Canadian data.     

Market liquidity,closeout procedures and initial margin for CCPs*

ABSTRACT

Closeout procedures enable central counterparties (CCPs) to respond to events that challenge the continuity of their normal operations, most frequently triggered by the default of one or more clearing members. The procedures typically entail three main phases: splitting, hedging, and liquidation. Together, these ensure the regularity of the settlement process through the prudent and orderly liquidation of the defaulters’ portfolios. Traditional approaches to CCPs’ margin requirements typically assume a simple closeout profile, not accounting for the ‘real life’ constraints embedded in the management of a default. The paper proposes an approach to assess how distinct closeout strategies may expose a CCP to different sets of risks and costs taking into account real-life frictions. The proposed approach enables the evaluation of a full spectrum of hedging strategies and the assessment of the trade-offs between the risk-reducing benefits of hedging and the transaction costs associated with it. Using an unexplored set of transactional level data, the proposed framework is evaluated assuming the hypothetical default of a real CCP clearing member. We consider the worst-case loss of a large interest rate swap portfolio observed over the past 10 years (i.e. 2005–2015) and show that an efficient hedging strategy which minimises risk may not be optimal when transaction costs are taken into account. The empirical analysis suggests that transaction costs are a significant factor and should be accounted for when designing a hedging strategy. Specifically, it is shown that the risk-reducing benefits arising from more tailored hedging strategies may introduce higher transaction costs, and therefore may change the effectiveness of the strategies.     

The Risk‐Return Relation in International Stock Markets

We investigate the risk‐return relation in international stock markets using realized variance constructed from MSCI (Morgan Stanley Capital International) daily stock price indices. In contrast with the capital asset pricing model, realized variance by itself provides negligible information about future excess stock market returns; however, we uncover a positive and significant risk‐return tradeoff in many countries after controlling for the (U.S.) consumption‐wealth ratio. U.S. realized variance is also significantly related to future international stock market returns; more importantly, it always subsumes the information content of its local counterparts. Our results indicate that stock market variance is an important determinant of the equity premium.     

Click or Call? Auction versus Search in the Over‐the‐Counter Market

Over‐the‐counter (OTC) markets dominate trading in many asset classes. Will electronic trading displace traditional OTC “voice” trading? Can electronic and voice systems coexist? What types of securities and trades are best suited for electronic trading? We study these questions by focusing on an innovation in electronic trading technology that enables investors to simultaneously search many bond dealers. We show that periodic one‐sided electronic auctions are a viable and important source of liquidity even in inactively traded instruments. These mechanisms are a natural compromise between bilateral search in OTC markets and continuous double auctions in electronic limit order books.     

关于商品市场场外掉期产品集中清算机制的研究

今年以来铁矿石价格明显上涨,其季度指数化定价已成趋势,而国际上铁矿石衍生品交易热度也在不断升温,其交易的金融化特征逐渐显现。文章以铁矿石场外掉期交易为例,介绍了近年来商品市场上场外掉期产品集中清算机制的构成,并研究了它的发展特征。     

DOES BOARD INDEPENDENCE MATTER FOR CORPORATE INSURANCE HEDGING?

We test the effect of board independence on corporate purchases of property insurance. We find that board independence increases the incidence of property insurance use but does not have a significant effect on the extent of property insurance use given that a firm decides to insure its assets. These findings are consistent with the argument that: (1) more independent boards view it necessary to have property insurance to manage asset‐loss risks and (2) excessive insurance or insurance purchases induced by managerial risk aversion and/or self‐interest does not benefit shareholders and so may not be supported by independent boards.     

Price dispersion in OTC markets: A new measure of liquidity

In this paper, we model price dispersion effects in over-the-counter (OTC) markets to show that, in the presence of inventory risk for dealers and search costs for investors, traded prices may deviate from the expected market valuation of an asset. We interpret this deviation as a liquidity effect and develop a new liquidity measure quantifying the price dispersion in the context of the US corporate bond market. This market offers a unique opportunity to study liquidity effects since, from October 2004 onwards, all OTC transactions in this market have to be reported to a common database known as the Trade Reporting and Compliance Engine (TRACE). Furthermore, market-wide average price quotes are available from Markit Group Limited, a financial information provider. Thus, it is possible, for the first time, to directly observe deviations between transaction prices and the expected market valuation of securities. We quantify and analyze our new liquidity measure for this market and find significant price dispersion effects that cannot be simply captured by bid-ask spreads. We show that our new measure is indeed related to liquidity by regressing it on commonly-used liquidity proxies and find a strong relation between our proposed liquidity measure and bond characteristics, as well as trading activity variables. Furthermore, we evaluate the reliability of end-of-day marks that traders use to value their positions. Our evidence suggests that the price deviations from expected market valuations are significantly larger and more volatile than previously assumed. Overall, the results presented here improve our understanding of the drivers of liquidity and are important for many applications in OTC markets, in general.     

Does the bond‐stock earnings yield differential model predict equity market corrections better than high P/E models?

We extend the literature on crash prediction models in three main ways. First, we explicitly relate crash prediction measures and asset pricing models. Second, we present a statistical significance test for crash prediction models. Finally, we propose a definition and a measure of robustness for these models. We apply our statistical test and measure the robustness of selected model specifications of the Price‐Earnings (P/E) ratio and Bond Stock Earning Yield Differential (BSEYD) measures. This analysis shows that the BSEYD and P/E ratios, were statistically significant robust predictors of corrections on the US equity market over the period 1964 to 2014.     

Optimal clearing arrangements for financial trades

Clearinghouses support financial trades by keeping records of transactions and by providing liquidity through short-term credit that participants clear periodically. We study efficient clearing arrangements for exchanges, where traders must clear with a clearinghouse, and for over-the-counter (OTC) markets, where traders can clear bilaterally. When clearing is costly, it can be efficient to subsidize OTC clearing by charging a higher clearing price for transactions conducted on exchanges. The clearinghouse then operates across both markets. Since clearinghouses offer credit, intertemporal incentives are needed to ensure settlement. When liquidity costs increase, concerns about default lead to a tightening of liquidity provision.     

美欧场外衍生品交易监管的制度改革

危机后美欧均将加强场外衍生品交易监管作为金融监管改革的一个重要领域，2014年以来纷纷加快了改革进度。在此背景下，本文对美欧场外衍生品交易监管改革的政策内容进行专题研究，分析了其在加强集中清算、严格风险防控措施、强制信息列报等方面的主要监管要求，并探讨了其对于国内金融机构衍生品业务发展的启示。     

Book‐to‐Market Equity,Asset Correlations and the Basel Capital Requirement

This paper examines the effect of book‐to‐market equity (BE/ME) on asset correlations under the Basel capital requirement. We find that BE/ME captures variations in asset correlations after controlling for firm size, default probability and industry effects from 1987 to 2011. Obligors with higher BE/ME exhibit lower asset correlations compared to those with lower BE/ME. Decomposing BE/ME into assets‐in‐place and growth options based on the asset pricing literature shows that obligors with more assets‐in‐place or more fixed assets have higher BE/ME and lower asset correlations than those with more growth options. Overall, our findings suggest that BE/ME is an additional important factor that may improve the estimates of asset correlations and thereby banks’ capital adequacy.     

How Informative Is Floating NAV When Securities Trade Infrequently?

We examine if a floating net asset value (NAV) increases the transparency of risk for investors. Using closed‐income fixed income funds we find little evidence that a floating NAV helps investors better understand the value and risk of a fund when a fund's assets trade infrequently. This potentially informs the debate regarding the adoption of a floating NAV in the money market industry. Our results suggest that it is unlikely that the benefits of floating NAV will outweigh the costs.     

Cream‐Skimming in Financial Markets

We propose a model in which investors may choose to acquire costly information that identifies good assets and purchase these assets in opaque (OTC) markets. Uninformed investors access an asset pool that has been cream‐skimmed by informed investors. When the quality composition of assets for sale is fixed, there is too much information acquisition and the financial industry extracts excessive rents. In the presence of moral hazard in origination, the social value of information varies inversely with information acquisition. Low quality origination is associated with large rents in the financial sector. Equilibrium acquisition of information is generically inefficient.     

The Dependency of the Banks' Assets and Liabilities: Evidence from Germany

Two decades of developments in risk‐transfer instruments may have fundamentally changed the extent to which banks practice on‐balance sheet term and liquidity transformation. These changes should be deliberated in on‐balance sheet asset‐liability dependencies. By using correlation analyses, we investigate asset‐liability dependency for all three sectors of German universal banks from 1994 to 2007 and find that it declined over our sample period. We also investigate whether asset‐liability dependency varies systematically with a bank's affinity for using risk‐transfer instruments, regulatory capital, and profitability and document several differences between the three sectors of German universal banks.