Model risk at central counterparties: is skin in the game a game changer?

Wenqian Huang and Elod Takats

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: As central counterparties (CCPs) have become systemic, their credit risk modeling has become critical for the global financial system. This paper empirically investigates CCPs’ incentives to model credit risk. Our hypothesis is that the more CCPs stand to lose from mismanagement, the more conservatively they model credit risk. Accordingly, we find that the higher the skin in the game, i.e., the CCP capital dedicated to credit risk, the lower the model risk is. The results are significant and robust across different model risk proxies. Consistent with our hypothesis, the association with other forms of capital is not significant. Our findings inform the policy debate on CCP capital regulation.

JEL-codes: F34 F42 G21 G38 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2024-07-01
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Published in International Journal of Central Banking, 1, July, 2024, 20(3), pp. 161 - 184. ISSN: 1815-4654

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http://eprints.lse.ac.uk/124360/ Open access version. (application/pdf)

Related works:
Journal Article: Model Risk at Central Counterparties: Is Skin in the Game a Game Changer? (2024)
Working Paper: Model risk at central counterparties: Is skin-in-the-game a game changer? (2020)
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