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Centralized clearing for over‐the‐counter derivatives

Gordon Rausser (Department of Agricultural and Resource Economics, University of California, Berkeley, Berkeley, California, USA)
William Balson (RBS Acquisition Company, Palo Alto, California, USA)
Reid Stevens (Department of Agricultural and Resource Economics, University of California, Berkeley, Berkeley, California, USA)

Journal of Financial Economic Policy

ISSN: 1757-6385

Article publication date: 9 November 2010

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Abstract

Purpose

Systemic risk propagated through over‐the‐counter (OTC) derivatives can best be managed by a public‐private central counterparty clearing house. The purpose of this paper is to outline the market microstructure necessary for such a clearing house.

Design/methodology/approach

The paper proposes using an request for quote platform with an active permissioning system that uses analytic approximations based on Monte Carlo simulation to estimate default risk and a two‐part pricing scheme to efficiently price that risk.

Findings

It is found that comprehensive clearing for complex and standardized derivatives is feasible using the clearing framework.

Research limitations/implications

This research is limited by the authors' ability to give empirical examples. The paper gives a short example with data, but given the constraints on length, cannot go into more detail.

Practical implications

This comprehensive clearing structure, in contrast to current proposed government regulations, will not drive out the “good” with the “bad” OTC derivative instruments.

Originality/value

This is the only paper the authors are aware of that outlines a detailed framework for clearing all OTC derivatives.

Keywords

Citation

Rausser, G., Balson, W. and Stevens, R. (2010), "Centralized clearing for over‐the‐counter derivatives", Journal of Financial Economic Policy, Vol. 2 No. 4, pp. 346-359. https://doi.org/10.1108/17576381011100865

Publisher

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Emerald Group Publishing Limited

Copyright © 2010, Emerald Group Publishing Limited