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Does a Central Clearing Counterparty Reduce Counterparty Risk?

Darrell Duffie and Haoxiang Zhu

The Review of Asset Pricing Studies, 2011, vol. 1, issue 1, 74-95

Abstract: We show whether central clearing of a particular class of derivatives lowers counterparty risk. For plausible cases, adding a central clearing counterparty (CCP) for a class of derivatives such as credit default swaps reduces netting efficiency, leading to an increase in average exposure to counterparty default. Further, clearing different classes of derivatives in separate CCPs always increases counterparty exposures relative to clearing the combined set of derivatives in a single CCP. We provide theory as well as illustrative numerical examples of these results that are calibrated to notional derivatives position data for major banks.

JEL-codes: G01 G14 G18 G28 (search for similar items in EconPapers)
Date: 2011
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