EconPapers    
Economics at your fingertips  
 

A simulation analysis of systemic counterparty risk in over-the-counter derivatives markets

Yuji Sakurai () and Tetsuo Kurosaki ()
Additional contact information
Yuji Sakurai: Federal Reserve Bank of Richmond
Tetsuo Kurosaki: Bank of Japan

Journal of Economic Interaction and Coordination, 2020, vol. 15, issue 1, No 10, 243-281

Abstract: Abstract In this paper, we propose a simulation framework to assess systemic risk in over-the-counter derivatives markets. We incorporate credit valuation adjustment (CVA), a mark-to-market estimate of counterparty credit risk booked on a bank’s balance sheet, into an otherwise standard structural model of credit risk. In this model, banks optimally hedge CVA by trading a credit default swap (CDS). The model aims to capture a possible adverse effect called “CDS–CVA feedback loop” from CVA hedging, which could increase CDS spreads due to a lack of liquidity in CDS markets and even further increase CVA because CVA is valued using the default probability extracted from CDS spreads. In order to measure systemic counterparty credit risk, we aggregate CVA across banks and examine how the distribution of systemic counterparty credit risk changes depending on underlying model parameters. We document that the tail risk of CVA increases nonlinearly when the liquidity of CDS markets declines. As an extension, we also model cost of posting collateral and discuss the trade-off between reducing systemic counterparty credit risk, stability of CDS markets and collateral cost.

Keywords: Mark-to-market accounting; Feedback effects; Collateral management; Margin requirement (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
http://link.springer.com/10.1007/s11403-019-00260-7 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

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:spr:jeicoo:v:15:y:2020:i:1:d:10.1007_s11403-019-00260-7

Ordering information: This journal article can be ordered from
http://www.springer. ... ry/journal/11403/PS2

DOI: 10.1007/s11403-019-00260-7

Access Statistics for this article

Journal of Economic Interaction and Coordination is currently edited by A. Namatame, Thomas Lux and Shu-Heng Chen

More articles in Journal of Economic Interaction and Coordination from Springer, Society for Economic Science with Heterogeneous Interacting Agents Contact information at EDIRC.
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().

 
Page updated 2021-01-14
Handle: RePEc:spr:jeicoo:v:15:y:2020:i:1:d:10.1007_s11403-019-00260-7