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Optimal Clearing Arrangements For Financial Trades

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Executive Summary

Clearinghouses support financial trades by keeping records of transactions and by providing liquidity through short-term credit that is periodically cleared by participants. The authors study efficient clearing arrangements for formal exchanges, where traders must clear with a clearinghouse, and for Over-The-Counter (OTC) markets, where trades can be cleared bilaterally. When clearing is costly, they show that it can be efficient to subsidize the clearing process for OTC transactions by charging a higher price for the clearing of transactions in exchanges. This necessitates a clearinghouse that operates across both markets. As a clearinghouse offers credit, intertemporal incentives are needed in order to ensure settlement.

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