Red-Blooded Risk: The Secret History of Wall Street

Numeraire

The natural numeraire for a derivatives dealer is not paper money but shares in the clearinghouse. Dealers own stakes in the clearinghouse and are responsible for its debts. Over-the-counter (OTC) derivatives are not traded on public exchanges, and may or may not have clearinghouses. If there is no multidealer clearinghouse, the dealer acts as its own clearinghouse, or else uses another dealer to clear trades.

In principle, you could set up a derivatives exchange and clearinghouse with no reference to paper money at all. As with a paper money issuing bank, you would probably want to contribute some equity capital so people would trust the institution initially, but even that is only a marketing essential, not an economic one. It's also true that having cash as one of the assets derivatives are written on is handy, because you don't have contracts for every possible thing someone might want to borrow or lend. But cash is not necessary.

To a derivatives end user, the numeraire is the net product of its economic activity, or the closest approximation that can be made from available contracts. An oil refiner, for example, can use the price of refined products minus the price of crude oil as a numeraire; a shipping company can use the price of commodities at port of consumption minus the price of those same commodities at port of production. This is the key to the economic function of futures markets. When your numeraire is your net economic product, you have no risk. When ...