LCH and Tilburg University
Welcome to the second issue of Volume 10 of The Journal of Financial Market Infrastructures. This issue contains three research papers in three different areas – central counterparties (CCPs), decentralized finance and retail payments (more precisely, cash usage) – and a forum paper on CCPs.
In the first paper in the issue, “Choice of margin period of risk and netting for computing margins in central counterparty clearinghouses: a Monte Carlo investigation”, Jayanth Varma and Vineet Virmani analyze the impact of gross initial margining versus net margining under various lengths of the period over which the future potential exposure is calculated, known as the margin period of risk (MPOR). They use Monte Carlo simulations to explore the effects of a longer MPOR for both systems of margin collection (net and gross), and they also take crowded trades (concentrated positions) into account. They find that gross margining is superior to net margining for high levels of client heterogeneity and crowded trades.
In the issue’s second paper, “Do DEXs work? Using Uniswap V2 to explore the effectiveness of decentralized exchanges”, Yuen Lo and Francesca Medda consider a so-called decentralized exchange (DEX) (an exchange based on a blockchain) and allow for four dimensions along which an exchange can be decentralized. One of the hypotheses that Lo and Medda investigate is whether a DEX that satisfies all four dimensions (Uniswap) can match the price of a centralized exchange. They use the atomic swap of Ether versus Tether, which is a commonly traded token pair. They find that in this case the DEX price is cointegrated with the centralized exchange price.
In our third research paper, “Falling use of cash and population age structure”, Tanai Khiaonarong and David Humphrey document the falling use of cash in circulation (in relation to other point-of-sale payment instruments such as cards and e-money) in a sample of 25 countries. They then investigate the usefulness of the population age structure as an explanatory variable for their observed cash usage pattern. They provide estimates to back up the intuition that, as younger generations use less cash than their predecessor generation, cash usage will drop further in the future.
The issue’s fourth and final paper, “ ‘Closing the gaps: moving forward on tail risks in central clearing’: a central bank of issue perspective” by Klaus Löber and Corinna Freund, appears in the Forum section. This paper is an updated version of a keynote speech delivered by the author during an online workshop on CCP risk management held by the European Association of CCP Clearing Houses and the Journal of Financial Market Infrastructures on October 13, 2020. The authors view the CCP from a central bank of issue perspective, ie, the financial stability concerns that a central bank of a jurisdiction may have if a CCP uses the fiat currency of that jurisdiction extensively. The papers focuses on planning for extreme end-ofthe- prefunded-waterfall events of a CCP and discusses the importance of financial resources, governance and disclosure.
I hope you enjoy reading this issue of The Journal of Financial Market Infrastructures.
Choice of margin period of risk and netting for computing margins in central counterparty clearinghouses: a Monte Carlo investigation
The authors provide a quantitative comparison for evaluating the impact of collecting margins in a gross-versus-net system with the margin period of risk (MPOR) set to between one and five days.
The authors investigate the effectiveness of the Ether–Tether liquidity pool on the Uniswap V2 and note that cointegration between the price set by the liquidity pool and its price elsewhere is a necessary condition of effectiveness.
The authors investigate the reduction of cash use across 25 countries, using three means of measurement and argue that one method is more appropriate than the others.
“Closing the gaps: moving forward on tail risks in central clearing”: a central bank of issue perspective
The authors explain the priorities for CCP recovery and resolution from a central bank of issue perspective, focussing on structural barriers and how gaps could be overcome.