Market structure, counterparty risk, and systemic risk

MPRA Paper from University Library of Munich, Germany

Abstract: Networks modeling bilaterally-cleared and centrally-cleared derivatives markets are shown to yield economically different price impact, volatility and contagion after an initial bankruptcy. A large bankruptcy in bilateral markets may leave a counterparty unable to expectationally prevent bankruptcy (checkmate) or make counterparties push markets and profit from contagion (hunting). In distress, bilateral markets amplify systemic risk and volatility versus centralized markets and are more subject to crises with real effects: contagion, unemployment, reduced tax revenue, higher transactions costs, lower risk sharing, and reduced allocative efficiency. Pricing distress volatility may suggest when to transition to central clearing. The model suggests three metrics for the well-connected part of a market -- number of counterparties, average risk aversion, and standard deviation of total exposure -- may characterize its fragility.

Keywords: network model; systemic risk; contagion; predatory trading (search for similar items in EconPapers)
JEL-codes: D49 G01 G28 (search for similar items in EconPapers)
Date: 2009-06-10, Revised 2011-12-19
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Citations: View citations in EconPapers (1)

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https://mpra.ub.uni-muenchen.de/36939/1/MPRA_paper_36939.pdf revised version (application/pdf)

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