Regulating Clearing in Networks

76 Pages Posted: 22 Nov 2022

See all articles by Pablo D'Erasmo

Pablo D'Erasmo

Federal Reserve Banks - Federal Reserve Bank of Philadelphia; University of Maryland - College Park

Selman Erol

Carnegie Mellon University - David A. Tepper School of Business

Guillermo Ordoñez

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: November 9, 2022

Abstract

Recent regulations in the U.S. and Europe incentivize the use of central counterparty clearing houses (CCP) to clear derivatives, arguably to create a less complex and more transparent interbank network that is less prone to financial instabilities. We construct a network model with endogenous exposures and show that the core and the periphery react asymmetrically to these regulations. The core values opacity more and adopts clearing less. Consequently, bilaterally netted exposures to the core increase. The regulation also makes the CCP more exposed to the core than the periphery was pre-regulation. This endogenous network reaction to the regulation creates the unanticipated effect of reducing financial stability through more frequent coordination failures that start at the core and spread to the periphery and the CCP. A novel dataset on U.S. counterparty exposures, before and after the regulations, confirm the model’s testable implications.

Keywords: Central Counterparty (CCP), Over-the-counter Trading (OTC), Interbank Networks, Information Transparency, Network Reactions

JEL Classification: G20, E50, N22

Suggested Citation

D'Erasmo, Pablo and Erol, Selman and Ordoñez, Guillermo, Regulating Clearing in Networks (November 9, 2022). Available at SSRN: https://ssrn.com/abstract=4273381 or http://dx.doi.org/10.2139/ssrn.4273381

Pablo D'Erasmo

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

University of Maryland - College Park ( email )

College Park, MD 20742
United States

Selman Erol (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

Guillermo Ordoñez

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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