Firm Capital Dynamics in Centrally Cleared Markets
41 Pages Posted: 26 Dec 2014 Last revised: 17 Jul 2019
Date Written: July 15, 2019
We develop a tractable continuous time model of multi-firm capital dynamics in a centrally cleared market. Our framework jointly models the strategic interactions between business operations of firms and their trading activities. We show that the endogenous allocation of firm capital between trading and operations can be recovered as the unique fixed point of a system of quadratic equations. Our model predicts that (i) there exists a convex relationship between equilibrium margins and firm capital in the cross-section, (ii) market collateral demand is positively correlated with size concentration, and (iii) size concentration is expected to increase over time. Using proprietary data on bilateral credit default swap exposures, we provide evidence that the convexity prediction is both economically and statistically significant, and validate our model assumption that firms hedge excess risks.
Keywords: Central clearing, Financial institutions, Firm capital dynamics, Bilateral CDS exposures
JEL Classification: C50, G18, G20
Suggested Citation: Suggested Citation