Abstract
Central counterparties (CCPs) are systemically important. When a clearing member defaults, the CCP sells the defaulted portfolio to surviving members in an auction, and losses, if any, are partly absorbed by a cash pool prefunded by the surviving members. We propose a tractable auction model that incorporates this salient feature. We find that “juniorization” – the CCP first uses prefunded cash of members who submit bad bids – increases the auction price. However, too aggressive juniorization can reduce members' total profit, presenting a misalignment between the CCP's objective and that of the members. A wider customer participation can increase both the auction price and the total profit of members and customers.
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