The Collateral Costs of Clearing

November 4, 2014
Issue 2014-04


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.

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JEL classification:
G13, G14, G18, G2, G28, D53, D82
clearing, central counterparty, segregation, novation, mutualization

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