The Design of a Central Counterparty

John Chi-Fong Kuong and Vincent Maurin

No 17679, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper analyzes the optimal allocation of losses via a Central Clearing Counterparty (CCP) in the presence of counterparty risk. A CCP can hedge this risk by mutualizing losses among its members. This protection, however, weakens members’ incentives for risk management. Delegating members’ risk monitoring to the CCP alleviates this tension in large markets. To discipline the CCP at minimum cost, members offer the CCP a junior tranche and demand capital contribution. Our results endogenize key layers of the default waterfall and deliver novel predictions on its composition, collateral requirements, and CCP ownership structure.

Keywords: Collateral; Monitoring (search for similar items in EconPapers)
JEL-codes: D86 G23 G28 (search for similar items in EconPapers)
Date: 2022-11
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