Counterparty risk, central counterparty clearing and aggregate risk

Binbin Deng
Additional contact information
Binbin Deng: Compass Lexecon
Authors registered in the RePEc Author Service: 邓彬斌

Annals of Finance, 2017, vol. 13, issue 4, No 1, 355-400

Abstract: Abstract I construct a model of bilateral trading of over-the-counter (OTC) derivatives to study the performance of central counterparty (CCP) clearing. I first show how buyers are exposed to counterparty risk under bilateral clearing. I then show how a CCP can fully insure against counterparty risk through risk-mutualization and achieve full idiosyncratic risk-sharing among market participants. I further demonstrate the impact of aggregate risk on CCP clearing and illustrate a scenario in which the CCP fails to provide full insurance against counterparty risk and full idiosyncratic risk-sharing collapses under severe aggregate risk. To insure against aggregate risk and retain full idiosyncratic risk-sharing, sellers’ capital resource is important on top of CCP mutualization. Finally, I allow buyers to costly search for sellers and study the implications of optimal search effort. I show how a moral hazard problem can arise if effort is unobservable, in which case full CCP insurance against counterparty risk is no longer optimal.

Keywords: Counterparty risk; Aggregate risk; Central counterparty (CCP) clearing; Optimal risk-sharing; Search and Moral hazard (search for similar items in EconPapers)
JEL-codes: D53 D82 G18 G23 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
http://link.springer.com/10.1007/s10436-017-0308-x Abstract (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:annfin:v:13:y:2017:i:4:d:10.1007_s10436-017-0308-x

Ordering information: This journal article can be ordered from
http://www.springer.com/finance/journal/10436/PS2

DOI: 10.1007/s10436-017-0308-x

Access Statistics for this article

Annals of Finance is currently edited by Anne Villamil

More articles in Annals of Finance from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().