Systemic Risk: The Dynamics under Central Clearing
Agostino Capponi (),
W. Allen Cheng () and
Sriram Rajan ()
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Agostino Capponi: Columbia University
W. Allen Cheng: Johns Hopkins University
Sriram Rajan: Office of Financial Research
No 15-08, Working Papers from Office of Financial Research, US Department of the Treasury
We develop a tractable model to resemble asset value processes of financial institutions trading with the central clearinghouse for risk mitigating purposes. Each institution allocates assets between its loan book and the account used to trade with the central clearinghouse. We show that a unique equilibrium allocation profile arises when institutions adjust trading positions to perfectly hedge risk stemming from their loan books. We then analyze the dynamic equilibrium path. As a regulatory monitoring tool, our model shows a buildup of systemic risk, manifested through the increase of market concentration, whose negative size externalities can be internalized via a self-funding systemic risk charge mechanism. We provide new testable predictions, including that (i) the volatility of the traded portfolio of a member can be forecasted by the collective capital committed by all others, (ii) hedging becomes increasingly costly for an institution as its asset value increases, (iii) market shocks have smaller impact on allocation decisions than operational shocks.
Keywords: Central Clearing; Central Counterparties; Systemic Risk; Self-Funding Systemic Risk Charge; Concentration Risks (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:ofr:wpaper:15-08
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