Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/187431
Authors: 
Kubitza, Christian
Pelizzon, Loriana
Getmansky, Mila
Year of Publication: 
2018
Series/Report no.: 
ICIR Working Paper Series 31/18
Abstract: 
Through the lens of market participants' objective to minimize counterparty risk, we provide an explanation for the reluctance to clear derivative trades in the absence of a central clearing obligation. We develop a comprehensive understanding of the benefits and potential pitfalls with respect to a single market participant's counterparty risk exposure when moving from a bilateral to a clearing architecture for derivative markets. Previous studies suggest that central clearing is beneficial for single market participants in the presence of a sufficiently large number of clearing members. We show that three elements can render central clearing harmful for a market participant's counterparty risk exposure regardless of the number of its counterparties: 1) correlation across and within derivative classes (i.e., systematic risk), 2) collateralization of derivative claims, and 3) loss sharing among clearing members. Our results have substantial implications for the design of derivatives markets, and highlight that recent central clearing reforms might not incentivize market participants to clear derivatives.
Subjects: 
Central Clearing
Counterparty Risk
Systematic Risk
OTC markets
Derivatives
Loss Sharing
Collateral
Margin
JEL: 
G01
G14
G18
G28
Document Type: 
Working Paper
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