How Fast Should Trades Settle?
Management Science, Forthcoming
56 Pages Posted: 8 Dec 2016 Last revised: 24 May 2019
Date Written: May 22, 2019
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 benefits impatient traders but increases borrowing needs. We find that flexible failure-to-deliver penalties reduce this tension, 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: Suggested Citation