Smart Settlement

Society for Financial Studies (SFS) Cavalcade, 2017

EFA 2017 Mannheim Meetings Paper

Rotman School of Management Working Paper No. 2881331

Swedish House of Finance Research Paper No. 17-4

52 Pages Posted: 8 Dec 2016 Last revised: 1 May 2018

Mariana Khapko

University of Toronto - Finance Area; Swedish House of Finance

Marius Zoican

Université Paris Dauphine - PSL Research University

Date Written: May 1, 2018

Abstract

Recent regulatory and FinTech initiatives aim to streamline post-trade infrastructures. Does faster settlement benefit markets? We build a model of intermediated trading with flexible settlement and imperfectly competitive securities lending. Faster settlement reduces counterparty risk, but increases borrowing needs. Rigid failure-to-deliver penalties trigger a toxic rat race, as traders aim to lock in low borrowing costs. Excess demand for fast settlement augments lenders' rents. Optimal penalties resemble put options on the security lending market: They protect traders against high settlement costs, but do not eliminate failures to deliver. Flexible penalties discipline security lender competition and facilitate faster trade settlement.

Keywords: Market design, trade settlement, security lending, counterparty risk

JEL Classification: D43, D47, G10, G20

Suggested Citation

Khapko, Mariana and Zoican, Marius, Smart Settlement (May 1, 2018). Society for Financial Studies (SFS) Cavalcade, 2017; EFA 2017 Mannheim Meetings Paper; Rotman School of Management Working Paper No. 2881331; Swedish House of Finance Research Paper No. 17-4. Available at SSRN: https://ssrn.com/abstract=2881331 or http://dx.doi.org/10.2139/ssrn.2881331

Mariana Khapko

University of Toronto - Finance Area ( email )

Toronto, Ontario M5S 3E6
Canada

Swedish House of Finance ( email )

Drottninggatan 98
Stockholm
Sweden

Marius Zoican (Contact Author)

Université Paris Dauphine - PSL Research University ( email )

Place du Maréchal de Lattre de Tassigny
Paris cedex 16, 75775
France

HOME PAGE: http://www.mariuszoican.org

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