Clearing , transparency , and collateral ∗

In an environment of Over-The-Counter trading with asymmetric information about the quality of the counterparty, we study traders’ incentives to screen their counterparties under different clearing arrangements. When traders can choose the clearing arrangement, they decide which types of transactions to clear under each arrangement, with significant consequences for transparency and collateral requirements. The key trade-off is between insurance and the value of information: on one hand risk averse traders want to smooth consumption and on the other hand they want to extract the largest feasible surplus from their counterparties. Choosing an arrangement that provides insurance, however, may prevent them from taking advantage of the private information they learn about their counterparty. As a result, insurance comes at the cost of losing transparency: when clearing arrangements differ in the degree of risk sharing they implement, then they also differ in the degree of transparency arising in equilibrium. This has significant consequences on the role of collateral. In environments with limited commitment, collateral plays two roles for risk averse traders: it is a means to discipline incentives and to self-insure at the same time. When insurance is provided by a clearing arrangement that implements risk sharing, collateral is primarily used to discipline incentives, since risk sharing comes at the cost of less information about the limited commitment of the counterparty. The opposite is true in the equilibrium with a clearing arrangement that cannot provide risk sharing but gives traders sufficient incentives to screen their counterparties.