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Pitfalls of central clearing in the presence of systematic risk

Author

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  • Kubitza, Christian
  • Pelizzon, Loriana
  • Getmansky Sherman, Mila
Abstract
Through the lens of market participants' objective to minimize counterparty risk, we investigate central clearing in derivatives markets, and its interaction with systematic risk, portfolio directionality, and loss sharing. Previous studies suggest that central clearing always reduces counterparty risk for a sufficiently large number of clearing members. We show that this is not the case - mostly because of loss sharing. Central clearing can increase counterparty risk, particularly during extreme market events, for traders with directional portfolios, and because CCPs mutualize default losses. Our results are consistent with the reluctance to clear derivative trades in the absence of a clearing obligation.

Suggested Citation

  • Kubitza, Christian & Pelizzon, Loriana & Getmansky Sherman, Mila, 2019. "Pitfalls of central clearing in the presence of systematic risk," SAFE Working Paper Series 235, Leibniz Institute for Financial Research SAFE, revised 2019.
    • Handle: RePEc:zbw:safewp:235
    DOI: 10.2139/ssrn.3278582
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    References listed on IDEAS

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    More about this item

    Keywords

    Central Clearing; Counterparty Risk; Systematic Risk; OTC markets; Derivatives; Margin;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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