Participants’ preferences for settlement netting of derivatives contracts

Abstract

This study examines market participants’ preference for netting when settling derivatives contracts by using social welfare, defined as the sum of all participants’ utilities. Equilibrium models are constructed for derivatives and margins with/without netting via participants’ utility maximization problems. The utilities and social welfare in equilibrium are then numerically computed. The numerical results demonstrate that netting reduces the required margin amount. However, when the posting margin’s funding cost equals the return on margin received, market participants exhibit no netting preference. By contrast, when the funding cost exceeds the return, all market participants prefer netting.