An Economic Examination of Collateralization in Different Financial Markets

This article makes a theoretical and empirical contribution to the study of collateralization by addressing several essential questions concerning the posting of collateral. We find evidence that financial institutions are sprinting to comply with the Dodd-Frank Act. In the new practice, contracts are continuously negotiated over-the-counter as usual, but cleared and settled via clearinghouses, as clearinghouses claim that cleared contracts would be economically equivalent to their OTC counterparts. As a result, swap premia in cleared market are determined in a similar way to those in OTC markets. We argue that this practice may not be appropriate because we notice that the clearing mechanics of a clearinghouse change the risk structure and thereby the asset prices. In fact, we find that cleared derivatives are not economically equivalent to their OTC counterparts.