A Theory of Collateral Requirements for Central Counterparties

Jessie Jiaxu Wang (), Agostino Capponi () and Hongzhong Zhang ()
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Jessie Jiaxu Wang: Department of Finance, W. P. Carey School of Business, Arizona State University, Tempe, Arizona 85287
Agostino Capponi: Department of Industrial Engineering and Operations Research, Columbia University, New York, New York 10027
Hongzhong Zhang: Department of Industrial Engineering and Operations Research, Columbia University, New York, New York 10027

Management Science, 2022, vol. 68, issue 9, 6993-7017

Abstract: This paper develops a framework for designing collateral requirements in a centrally cleared market. Clearing members post collateral—initial margins and default funds—to increase their pledgeable income, thereby committing to risk management. The two types of collateral, however, are not perfect substitutes. By achieving loss mutualization, default funds are economically more efficient than initial margins in aligning members’ incentives for risk management ex ante. The optimal mix of collateral resources balances the efficiency in providing incentives with their relative opportunity costs. Our model predicts increased use of initial margins under stringent capital requirements and of default funds under distressed market scenarios.

Keywords: central counterparty; collateral; initial margins; default funds; macro-prudential policy (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:68:y:2022:i:9:p:6993-7017

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