The Collateral Costs of Clearing

Cyril Monnet and Dr. Thomas Nellen

Issue
2014-04

Pages
49

JEL classification
G13, G14, G18, G2, G28, D53, D82

Keywords
clearing, central counterparty, segregation, novation, mutualization

Year
2014

In this working paper, we study the three generic clearing arrangements in the presence of two-sided limited commitment: simple bilateral clearing, segregated collateral clearing through a third party, and - most sophisticated of all - central counterparty (CCP) clearing. Clearing secures the settlement of obligations from over-the-counter (OTC) forward contracts that smooth the income of risk-averse agents. Clearing requires collateral to guarantee settlement; this is costly, as it reduces income from investment. While welfare is greater under more sophisticated clearing arrangements, we find that these are also more demanding in terms of collateral.