Risk mutualization and financial stability: recovering and resolving a central counterparty

Radoslav Raykov

Journal of Financial Market Infrastructures

Abstract: Risk mutualization is essential for a central counterparty’s (CCP’s) ability to survive defaults. This paper investigates how financial market participants respond to risk mutualization implemented by a CCP using assessments after a large credit loss. The model compares two clearing regimes – with and without an outside clearing option – and investigates two response channels to an assessment: reduced contract size and increased default risk. The analysis shows that (1) defaults to assessments are more likely when there is an outside option; (2) the strategic default risk channel dominates, while the optimal contract size is unaffected; (3) the likelihood of strategic default increases with the likelihood of an assessment at a rate of at least 1:1; and (4) CCPs clearing larger contracts could face greater challenges recovering with cash calls. The analysis provides rationale for the existence of CCP resolution regimes and outlines the boundary between recovery and resolution.

References: Add references at CitEc
Citations:

Downloads: (external link)
https://www.risk.net/journal-of-financial-market-i ... central-counterparty (text/html)

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:rsk:journ7:5384666

Access Statistics for this article

More articles in Journal of Financial Market Infrastructures from Journal of Financial Market Infrastructures
Bibliographic data for series maintained by Thomas Paine ().