Optimal clearing arrangements for financial trades |
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Authors: | Thorsten KoepplCyril Monnet Ted Temzelides |
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Institution: | a Queen's University, Canada b Research Department, Federal Reserve Bank of Philadelphia, 10 Independence Mall, Philadelphia PA 19106, United States c Rice University, United States |
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Abstract: | 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. |
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Keywords: | Clearing OTC vs exchanges Private information Liquidity costs Default |
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