Working Paper: NBER ID: w15634
Authors: Angelo Riva; Eugene N. White
Abstract: Over the course of the nineteenth century, the struggles of Paris Bourse to manage counterparty risk revealed the awkward choices that face derivatives exchanges. Shortly after it was founded, the stock exchange, primarily a forward market, instituted a mutual guarantee fund to prevent broker failures from snowballing into a general liquidity crisis. The creation of the fund then forced the Bourse to search for mechanisms to control moral hazard. To study the determinants of broker failures, we collected new individual data on defaulting brokers and describe the evolving regulatory regime. To identify the factors behind the annual number of broker failures we use negative binominal regressions. To explain individual brokers' duration in office, we employ a proportional hazard model, while logit regressions examine the causes of individual broker failures. In addition to declines in asset prices and trading volume, the moral hazard from the mutual guarantee fund contributed to brokers' defaulting on their obligations. The Bourse faced a conundrum; when it finally imposed a tight regulatory regime that limited risk, trading began to migrate off the exchange to less regulated markets.
Keywords: Counterparty Risk; Paris Bourse; Broker Failures; Regulatory Regimes; Financial Crises
JEL Codes: G0; G01; G18; N23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| moral hazard from mutual guarantee fund (H81) | increase in broker defaults (G24) |
| tighter regulations after 1882 crash (G18) | initially reduce defaults (Y20) |
| tighter regulations after 1882 crash (G18) | increase overall risk in financial system (F65) |
| declines in asset prices (G19) | broker failures (G24) |
| declines in trading volumes (F44) | broker failures (G24) |
| history of office occupancy from defaulting brokers (L85) | heightened risk of failure (G33) |