The Inefficiency of Clearing Mandates

By Todd Zywicki on March 17, 2011

Dr. Craig Pirrong, Director at Global Economics Group, lays out the advantages and risks to a mandated clearing requirement for the over-the-counter derivatives market. In The Inefficiency of Clearing Mandates (Policy Analysis, No. 665, 2010), Dr. Pirrong describes the dynamics of counterparty risk in the derivatives market while discussing the relative importance of both the risk that arises from the price risk of the instrument at issue and the financial condition of the counterparty. He then evaluates how bilateral markets and clearinghouses manage these two risks and demonstrates that resolving and replacing defaulted trades is the primary resolution problem facing both market structures. Finally, Dr. Pirrong suggests an auction alternative designed to address this issue. The Inefficiency of Clearing Mandates