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Stress Testing Networks: The Case of Central Counterparties

Richard Berner, Stephen Cecchetti () and Kermit Schoenholtz

No 13604, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Stress tests applied to individual institutions are an important tool for evaluating financial resilience. However, financial systems are typically complex, heterogeneous and rapidly changing, raising questions about the adequacy of conventional tests. In this paper, we interpret the current stress test practice from a network perspective, highlighting central counterparties (CCPs) as an example of a critical network hub. Networks that include CCPs involve deep and broad interconnections, making stress testing a challenging task. We propose supplementing both private and supervisory CCP stress tests with a high-frequency indicator constructed from a market-based estimate of the conditional capital shortfall (SRISK) of the CCP's clearing members. Applying our measure to two large CCPs, we analyze how they can transmit and amplify shocks across borders, conditional on the exhaustion of prefunded resources. Our results highlight how the network created by central clearing can act as an important transmission mechanism for shocks emanating from Europe.

Keywords: CCP; central counterparties; financial network; financial regulation; Financial Stability; Resolution; SRISK; Stress Testing (search for similar items in EconPapers)
JEL-codes: G18 G23 G28 G32 (search for similar items in EconPapers)
Date: 2019-03
New Economics Papers: this item is included in nep-cba, nep-ict and nep-rmg
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