How Fast Should Trades Settle?

Mariana Khapko () and Marius Zoican ()
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Mariana Khapko: Rotman School of Management, University of Toronto Scarborough, Toronto, Ontario M1C 1A4, Canada;
Marius Zoican: Rotman School of Management, University of Toronto, Mississauga, Mississauga, Ontario L5L 1C6, Canada

Management Science, 2020, vol. 66, issue 10, 4573-4593

Abstract: Recent regulatory and industry initiatives aim to streamline post-trade infrastructures. Does faster settlement benefit markets? We build a model of intermediated trading with imperfectly competitive securities lending. Faster settlement benefits impatient traders but increases borrowing needs. We find that flexible failure-to-deliver penalties reduce this tension, disciplining security lender competition and allowing for real-time settlement. Optimal penalties resemble put options on the lending market: they protect traders against high settlement costs but do not eliminate failures to deliver. Mandating automatic security borrowing to prevent failures to deliver triggers a toxic settlement rat race to lock in low borrowing costs.

Keywords: market design; trade settlement; security lending; counterparty risk (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (4)

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