Clearing Financial Networks: Impact on Equilibrium Asset Prices and Seniority of Claims

Abstract

In financial derivatives networks clearinghouses have been mandated as de facto central nodes: they are buyers to the sellers of financial contracts and resellers to the ultimate buyers. Other services aim at solving various network problems such as reducing cycles. All these services face complex challenges, ranging from the direct effect on the network topology to the indirect effects on asset prices and on the end users.

In this tutorial, we offer an introduction into the quantitative modeling of clearing systems. We analyze joint equilibria for the network payments and the asset prices. We raise two main points that have received less attention in the literature. The first point is that an equilibrium price for the asset prices may not be achieved in a general payment network. The second point is that trade-compression and clearinghouses modify the seniority structure in the network, and end users that are not part of multi-lateral clearing arrangements become de facto junior. The comprehensive study of these issues with operations research tools would lead to a promising research agenda.

Keywords: Systemic Risk, Financial Network, Central Clearing, Portfolio Compression

JEL Classification: C44, C54, C62, G01, G18, G32