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Can the Financial Markets Privately Regulate Risk?: The Development of Derivatives Clearinghouses and Recent over-the-Counter Innovations

Randall S. Kroszner
Journal of Money, Credit and Banking
Vol. 31, No. 3, Part 2: The Role of Central Banks in Money and Payments Systems (Aug., 1999), pp. 596-618
DOI: 10.2307/2601077
Stable URL: http://www.jstor.org/stable/2601077
Page Count: 23
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Can the Financial Markets Privately Regulate Risk?: The Development of Derivatives Clearinghouses and Recent over-the-Counter Innovations
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Abstract

This paper explores how organization and contract design has evolved to address regulatory challenges in risk management. In the early part of the century, futures exchanges responded to credit risks by developing clearinghouses that act as guarantors. The liability structure of the clearinghouse involves mutualization of risks through "partial permanent" integration of the exchange members. Bank clearinghouses historically involved "contingent" integration and risk mutualization during panics. Recent organizational innovations have allowed the risk-control benefits of the clearinghouse to be replicated in the decentralized over-the-counter derivatives markets. Credit rating agencies and advances in risk modeling are key to permitting the recent "disintegration," which has implications for the scope of public versus private regulation in banking and financial markets.

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