The Value of Central Clearing
88 Pages Posted: 1 Oct 2018 Last revised: 6 Aug 2019
Date Written: August 5, 2019
I study a contracting innovation that suddenly insulated traders of hedging contracts against counterparty risk: central clearing counterparties (CCPs) for derivatives. The first CCP was created in Le Havre (France) in 1882, in the coffee futures market. Using triple difference-in-differences estimation, I show that central clearing changed the geography of trade flows Europe-wide, to the benefit of Le Havre. Inspecting the mechanism using trader-level data, I find that the CCP solved both a "missing market" problem and adverse selection issues. Central clearing also facilitated entry of new traders in the market. The successful contracting innovation quickly spread to other exchanges.
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