Central counterparties

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(1)No. 2008/42 Central Counterparties Thorsten V. Koeppl and Cyril Monnet. Center for Financial Studies Goethe-Universität Frankfurt House of Finance Grüneburgplatz 1 60323 Frankfurt Deutschland. Telefon: +49 (0)69 798-30050 Fax: +49 (0)69 798-30077 http://www.ifk-cfs.de E-Mail: [email protected].

(2) Center for Financial Studies. The Center for Financial Studies is a nonprofit research organization, supported by an association of more than 120 banks, insurance companies, industrial corporations and public institutions. Established in 1968 and closely affiliated with the University of Frankfurt, it provides a strong link between the financial community and academia. The CFS Working Paper Series presents the result of scientific research on selected topics in the field of money, banking and finance. The authors were either participants in the Center´s Research Fellow Program or members of one of the Center´s Research Projects. If you would like to know more about the Center for Financial Studies, please let us know of your interest.. Prof. Dr. Jan Pieter Krahnen. Center for Financial Studies House of Finance Goethe-Universität Grüneburgplatz 1 60323 Frankfurt am Main Deutschland. Prof. Volker Wieland, Ph.D.. Telefon: +49 (0)69 798-30050 Fax: +49 (0)69 798-30077 http://www.ifk-cfs.de E-Mail: [email protected].

(3) CFS Working Paper No. 2008/42 Central Counterparties* Thorsten V. Koeppl1 and Cyril Monnet2. May 28, 2008 Abstract: Central counterparties (CCPs) have increasingly become a cornerstone of financial markets infrastructure. We present a model where trades are time-critical, liquidity is limited and there is limited enforcement of trades. We show a CCP novating trades implements efficient trading behaviour. It is optimal for the CCP to face default losses to achieve the efficient level of trade. To cover these losses, the CCP optimally uses margin calls, and, as the default problem becomes more severe, also requires default funds and then imposes position limits.. JEL Classification: G20, G30.. Keywords: Central Counterparty; Clearing; Default; Collateral; Risk Management.. *. We are grateful for comments from Charlie Kahn, Jean-Charles Rochet and Jens Tapking and seminar participants at the Bank of England, the Cass Business School, the CEA meetings, the Bank of Canada, the Econometric Society Meetings, the SED meetings and the CEPR conference on Competition and Efficiency in Payment and Security Settlement Systems. Furthermore, we thank the Financial Markets Infrastructure Division at the Bank of England for their hospitality where some of this research was initiated. The usual disclaimers apply.. 1. Queen.s University, Department of Economics Kingston, Ontario, K7L 3N6; e-mial: [email protected]. 2. Federal Reserve Bank of Philadelphia, Research Department, Ten Independence Mall Philadelphia, PA 19106-1574; e-mail: [email protected].

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(82) CFS Working Paper Series: No.. Author(s). Title. 2008/41. Terrence Hendershott Charles M. Jones Albert J. Menkveld. Does Algorithmic Trading Improve Liquidity?. 2008/40. Jonathan Field Jeremy Large. Pro-Rata Matching and One-Tick Futures Markets. 2008/39. Giovanni Cespa Thierry Foucault. Insiders-Outsiders, Transparency and the Value of the Ticker. 2008/38. Rachel J. Huang Alexander Muermann Larry Y. Tzeng. Hidden Regret in Insurance Markets: Adverse and Advantageous Selection. 2008/37. Alexander Muermann Stephen H. Shore. Monopoly Power Limits Hedging. 2008/36. Roman Inderst. Retail Finance: Bringing in the Supply Side. 2008/35. Dimitris Christelis Tullio Jappelli Mario Padula. Cognitive Abilities and Portfolio Choice. 2008/34. Tullio Jappelli Marco Pagano. Information Sharing and Credit: Firm-Level Evidence from Transition Countries. 2008/33. Tullio Jappelli Marco Pagano. Financial Market Integration under EMU. 2008/32. Fancis X. Diebold Georg H. Strasser. On the Correlation Structure of Microstructure Noise in Theory and Practice. Copies of working papers can be downloaded at http://www.ifk-cfs.de.

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