How fast should trades settle?

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

50 Pages Posted: 8 Dec 2016 Last revised: 13 Sep 2018

Mariana Khapko

University of Toronto - Finance Area; Swedish House of Finance

Marius Zoican

University of Toronto - Finance Area

Date Written: September 12, 2018

Abstract

Recent regulatory and industry initiatives aim to streamline post-trade infrastructures. Does faster settlement benefit markets? We build a model of intermediated trading with imperfectly competitive securities lending. Faster settlement reduces counterparty risk but increases borrowing needs. We find that flexible failure-to-deliver penalties reduce the tension between credit risk and liquidity, disciplining security lender competition and allowing for real-time settlement. Optimal penalties resemble put options on the lending market: They protect traders against high settlement costs, but do not eliminate failures-to-deliver. Mandating automatic security borrowing to prevent failures-to-deliver triggers a toxic settlement rat race to lock in low borrowing costs.

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

JEL Classification: D43, D47, G10, G20

Suggested Citation

Khapko, Mariana and Zoican, Marius, How fast should trades settle? (September 12, 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)

University of Toronto - Finance Area ( email )

105 St George Street
Toronto, Ontario M5S 3E6
Canada

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

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