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Firm capital dynamics in centrally cleared markets
Author(s) -
Capponi Agostino,
Cheng W. Allen,
Rajan Sriram
Publication year - 2020
Publication title -
mathematical finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.98
H-Index - 81
eISSN - 1467-9965
pISSN - 0960-1627
DOI - 10.1111/mafi.12236
Subject(s) - clearance , economics , swap (finance) , collateral , hedge , econometrics , capital (architecture) , microeconomics , monetary economics , financial economics , finance , history , ecology , archaeology , biology , medicine , urology
We develop a tractable continuous time model of multifirm capital dynamics in a centrally cleared market. Our framework jointly models the strategic interactions between business operations of firms and their trading activities. We show that the endogenous allocation of firm capital between trading and operations can be recovered as the unique fixed point of a system of quadratic equations. Our model predicts that (a) there exists a convex relationship between equilibrium margins and firm capital in the cross‐section, (b) market collateral demand is positively correlated with size concentration, and (c) size concentration is expected to increase over time. Using proprietary data on bilateral credit default swap exposures, we provide evidence that the convexity prediction is both economically and statistically significant and validate our model assumption that firms hedge excess risks.