Firm Capital Dynamics in Centrally Cleared Markets

Mathematical Finance, Forthcoming

41 Pages Posted: 26 Dec 2014 Last revised: 22 Aug 2019

See all articles by Agostino Capponi

Agostino Capponi

Columbia University

W. Cheng

AQR Capital Management, LLC

Sriram Rajan

Government of the United States of America - Office of Financial Research

Date Written: August 21, 2019

Abstract

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

Capponi, Agostino and Cheng, Wan-Schwin and Rajan, Sriram, Firm Capital Dynamics in Centrally Cleared Markets (August 21, 2019). Mathematical Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2542684 or http://dx.doi.org/10.2139/ssrn.2542684

Agostino Capponi (Contact Author)

Columbia University ( email )

S. W. Mudd Building
New York, NY 10027
United States

Wan-Schwin Cheng

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Sriram Rajan

Government of the United States of America - Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

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