Finance and Economics Discussion Series (FEDS)
May 2023 (Revised August 2024)
Optimal Bidder Selection in Clearing House Default Auctions
Rodney Garratt, David Murphy, Travis Nesmith, and Xiaopeng Wu
Abstract:
Central counterparties' ability to hold successful default auctions is critically important to financial stability. However, due to the unique features of these auctions, standard auction theory results do not apply. We present a model of CCP default auctions that incorporates both the vital, but non-standard, objective of minimizing the likelihood it suffers reputationally damaging losses and the potential for information leakage to affect CCP members' private portfolio valuations. This gives insight into the key question of how CCPs should select auction participants. In particular, we prove that an entry fee, by appropriately incentivizing some members not to enter the auction, can maximize the probability of auction success. The result is novel, both in auction theory and as a mechanism for CCP auction design.
Keywords: Auctions; Central counterparties; CCPs; Default; Derivatives; Entry mechanism; Financial stability; Systemic risk
DOI: https://doi.org/10.17016/FEDS.2023.033r1
PDF: Full Paper
Original Paper: PDF | Accessible materials (.zip)
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