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Optimal Bidder Selection in Clearing House Default Auctions

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Abstract

Default auctions at central counterparties (or 'CCPs') are critically important to financial stability. However, due to their unique features and challenges, standard auction theory results do not immediately apply. This paper presents a model for CCP default auctions that incorporates the CCP's non-standard objective of maximizing success above a threshold rather than revenue, the key question of who participates in the auction and the potential for information leakage affecting private portfolio valuations. We show that an entry fee, by appropriately inducingmembers to participate or not, can maximize the probability the auction succeeds. The result is novel, both in auction theory and as a mechanism for CCP auction design.

Suggested Citation

  • Rodney Garratt & David Murphy & Travis D. Nesmith & Xiaopeng Wu, 2023. "Optimal Bidder Selection in Clearing House Default Auctions," Finance and Economics Discussion Series 2023-033, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2023-33
    DOI: 10.17016/FEDS.2023.033
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    1. Landsberger, Michael, 2007. "Non-existence of monotone equilibria in games with correlated signals," Journal of Economic Theory, Elsevier, vol. 132(1), pages 119-136, January.
    2. Han Hong, 2000. "Increasing Competition and the Winner's Curse: Evidence from Procurement," Econometric Society World Congress 2000 Contributed Papers 1628, Econometric Society.
    3. Songzi Du & Haoxiang Zhu, 2017. "What is the Optimal Trading Frequency in Financial Markets?," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 84(4), pages 1606-1651.
    4. Fernando V. Cerezetti & Emmanouil N. Karimalis & Ujwal Shreyas & Anannit Sumawong, 2019. "Market liquidity, closeout procedures and initial margin for CCPs," The European Journal of Finance, Taylor & Francis Journals, vol. 25(7), pages 599-631, May.
    5. Murphy, David & Nahai-Williamson, Paul, 2014. "Financial Stability Paper 30: Dear Prudence, won’t you come out to play? Approaches to the analysis of CCP default fund adequacy," Bank of England Financial Stability Papers 30, Bank of England.
    6. Milgrom,Paul, 2004. "Putting Auction Theory to Work," Cambridge Books, Cambridge University Press, number 9780521536721, September.
    7. Han Hong & Matthew Shum, 2002. "Increasing Competition and the Winner's Curse: Evidence from Procurement," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 69(4), pages 871-898.
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    More about this item

    Keywords

    Clearinghouse; Derivatives; futures and options; Central counterparties; CCPs; Bidder selection; Auction theory; Default auctions;
    All these keywords.

    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other

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