Dealers' Competition and Control of a Central Counterparty: When Lower Risk Increases Profit
39 Pages Posted: 17 Mar 2012 Last revised: 26 Jul 2013
Date Written: June 1, 2013
Central counterparties (CCPs) are becoming central to over-the-counter (OTC) markets. A CCP limits counterparty risk but raises entry barriers. We analyze the trade-off between dealers’ equilibrium default risk and competition in an OTC market with imperfect competition and endogenous default probability. We find that (i) CCP members favor entry restrictions and binding risk controls as a device to commit to less competition, (ii) restricting entry maximizes welfare when dealers’ transfer risk efficiently relative to their market power, and (iii) free entry reaches the first-best welfare if the CCP can limit risk-taking.
Keywords: Clearing, Central Counterparty, Default, Competition, membership requirements
JEL Classification: G21, G28, G32, G34
Suggested Citation: Suggested Citation