Central Counterparty Auction Design

35 Pages Posted: 15 Aug 2017

See all articles by Gerardo Ferrara

Gerardo Ferrara

Bank of England

Xin Li

University of Westminster,Westminster Business School

Date Written: August 11, 2017

Abstract

We analyze the role of auctions in managing the default of a clearing member in a generic central counterparty (CCP). We first consider three established alternative sealed bid auction formats in which clearing members simultaneously submit bids for a defaulting clearing member’s portfolio: first price without penalty, first price with penalty, and first price with budget constraints. Under our assumptions regarding bidders’ behaviour, although the revenue of the portfolio by the CCP might be the same for these auction formats mentioned above, there could be significant differences in the externalities arising from each of them. Additionally, this paper considers how mechanisms to incentivize competitive bidding could, in some circumstances, have adverse implications for financial stability by inefficiently distributing losses to surviving clearing members. In response to these potential adverse implications, we propose a fourth auction type — second price with loss sharing — which takes into account a bidder’s consideration that may bear part of the CCP’s losses.

Keywords: Auction, default management, central counterparty

JEL Classification: D44, G18

Suggested Citation

Ferrara, Gerardo and Li, Xin, Central Counterparty Auction Design (August 11, 2017). Bank of England Working Paper No. 669, Available at SSRN: https://ssrn.com/abstract=3018613 or http://dx.doi.org/10.2139/ssrn.3018613

Gerardo Ferrara (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Xin Li

University of Westminster,Westminster Business School ( email )

35 Marylebone Road
London NW1 5LS
United Kingdom

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