Inducing Agents to Report Hidden Trades: A Theory of an Intermediary*

Abstract

When contracts are unobserved, agents may have the incentive to promise the same asset to multiple counterparties and subsequently default. I construct an optimal mechanism that induces agents to reveal all their trades voluntarily. The mechanism allows agents to report every contract they enter, and it makes public the names of agents who have reached some prespecified position limit. In some cases, an agent's position limit must be higher than the number of contracts he enters in equilibrium. The mechanism has some features of a clearinghouse.

Clearing, Counterparty Risk, and Aggregate Risk

“…In our analysis, the bene…t of centralized clearing is the mutualization of counterparty default risk. Also, while centralized clearing makes excessive risk positions observable in Acharya and Bisin (2010) or elicitable in Leitner (2012), the bene…t of centralized clearing in our analysis applies even when the e¤ort to search for creditworthy counterparties is observable.…”

“…From a normative viewpoint, our contribution is thus to identify the conditions and the design under which centralized clearing brings about e¢ ciency gains. Acharya and Bisin (2010) and Leitner (2012) also o¤er insights into the optimal design of centralized clearing. As noted by Acharya and Bisin (2010), no protection buyer can control economize on settlement costs, see Koeppl, Monnet and Temzelides (2011).the trades of his counterparty with other investors in OTC markets.…”

“…Acharya and Bisin (2010) show how centralized clearing can eliminate such ine¢ ciencies by implementing price schedules that penalize the creation of counterparty risk. Furthermore, Leitner (2012) shows how, within a central mechanism, position limits prevent agents from entering into excessive contracts. Our focus is di¤erent.…”

“…Our focus is di¤erent. In Acharya and Bisin (2010) and Leitner (2012), the bene…t of centralized clearing is that it enables to control the risk exposure of protection sellers. In our analysis, the bene…t of centralized clearing is the mutualization of counterparty default risk.…”

Stress Tests and Information Disclosure

“…The …rst strand is the literature on the disclosure of regulatory information in …nancial markets. This literature is reviewed in Goldstein and Sapra (2013) and Leitner (2014), 3 who show that, while disclosure can enhance market discipline, disclosure can also create problems, such as reducing the regulator's ability to collect information from banks (Prescott, 2008;Leitner, 2012), reducing the regulator's ability to learn from market prices (Bond and Goldstein, 2015), inducing bank managers to window dress, or leading economic agents to put too much weight on public signals (Morris and , and …scal capacity (Faria-e-Castro, Martinez, and Philippon, 2017). 4 Our paper analyzes a di¤erent tradeo¤, which originates from risk sharing concerns and which is based on the idea that, while disclosure reduces risk sharing opportunities as in Hirshleifer (1971), it is sometimes necessary to prevent risksharing markets from breaking down.…”