The Limits Of Central Counterparty Clearing: Collusive Moral Hazard And Market Liquidity

Thorsten Koeppl

No 1312, Working Paper from Economics Department, Queen's University

Abstract: Can central counterparty (CCP) clearing control counterparty risk in the presence of risk taking that can aggravate such risk? When counterparty risk is not observable, I show that central clearing leads to higher collateral requirements for two different reasons. Without collusion about risk taking, a CCP offering diversification of risk cannot selectively forgo incentives for transactions that use collateral only for insurance. With collusion about risk taking, a CCP needs to charge collateral in line with the worst counterparty quality to control risk taking. Requiring more collateral reduces market liquidity and worsens incentives causing a feedback effect that amplifies collateral costs.

Keywords: CCP Clearing; Counterparty Risk; Moral Hazard; Collateral; Market Liquidity (search for similar items in EconPapers)
JEL-codes: D82 D83 G32 G38 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2013-06
New Economics Papers: this item is included in nep-cta
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:qed:wpaper:1312

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