Central clearing and loss allocation rules

Dominic Cucic

Journal of Financial Markets, 2022, vol. 59, issue PA

Abstract: I study the effects of central clearing in over-the-counter derivative markets in a simple model of derivative trading. When risk-sharing is limited by moral hazard problems facing protection sellers, central counterparties (CCPs) facilitate risk-sharing by mutualizing idiosyncratic counterparty risk and economizing on costly margin calls. When clearing members’ defaults are correlated, CCPs mutualize losses across its members. CCPs facing their own moral hazard problems can be induced to manage risk prudently by absorbing losses with CCP capital. A clearing fee can compensate CCPs for raising costly capital but may be prohibitively costly, warranting a return to bilateral trading.

Keywords: Moral hazard; Central clearing; Counterparty risk; Margins; Capital (search for similar items in EconPapers)
JEL-codes: D82 G22 G28 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finmar:v:59:y:2022:i:pa:s1386418121000434

DOI: 10.1016/j.finmar.2021.100662

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