Central Counterparty Default Waterfalls and Systemic Loss

Mark Paddrik () and Simpson Zhang
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Simpson Zhang: Office of the Comptroller of the Currency

No 213, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: Central counterparties (CCP) make financial markets more resilient through default waterfalls that sequentially manage and allocate resources to cover defaults of clearing members and clients. However, the amount of resources collected and how resources are allocated along the default waterfall can create competing objectives for the CCP. In this paper, we develop a model to measure the resiliency of a default waterfall's design, accounting for the interconnected nature of payment obligations and the distribution of losses among firms. We use a unique and comprehensive dataset containing both bilateral and centrally cleared CDS transactions to address the impact of default waterfall design on a systemic loss. We show that the distribution of segregated and shared resources in the waterfall strongly influences CCP resiliency and the participation incentives of member firms. Our results indicate that real-world CCP waterfall resource allocations and sizes are currently built to limit member losses at the potential expense of greater systemic losses.

Date: 2019
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Related works:
Journal Article: Central Counterparty Default Waterfalls and Systemic Loss (2023)
Working Paper: Central Counterparty Default Waterfalls and Systemic Loss (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed019:213

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