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Central clearing and loss allocation rules

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  • Cucic, Dominic

Abstract

I study the effects of central clearing in over-the-counter derivative markets in a simple model of derivative trading. When risk-sharing is limited by moral hazard problems facing protection sellers, central counterparties (CCPs) facilitate risk-sharing by mutualizing idiosyncratic counterparty risk and economizing on costly margin calls. When clearing members’ defaults are correlated, CCPs mutualize losses across its members. CCPs facing their own moral hazard problems can be induced to manage risk prudently by absorbing losses with CCP capital. A clearing fee can compensate CCPs for raising costly capital but may be prohibitively costly, warranting a return to bilateral trading.

Suggested Citation

  • Cucic, Dominic, 2022. "Central clearing and loss allocation rules," Journal of Financial Markets, Elsevier, vol. 59(PA).
    • Handle: RePEc:eee:finmar:v:59:y:2022:i:pa:s1386418121000434
    DOI: 10.1016/j.finmar.2021.100662
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    References listed on IDEAS

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    Cited by:

    1. Christina Brinkmann, 2023. "Differentiation in Risk Profiles," CRC TR 224 Discussion Paper Series crctr224_2023_444, University of Bonn and University of Mannheim, Germany.
    2. Demange, Gabrielle & Piquard, Thibaut, 2023. "On the choice of central counterparties in the EU," Journal of Financial Markets, Elsevier, vol. 64(C).
    3. Christina Brinkmann, 2022. "Imperfect Competition in Derivatives Markets," ECONtribute Discussion Papers Series 153, University of Bonn and University of Cologne, Germany.

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    More about this item

    Keywords

    Moral hazard; Central clearing; Counterparty risk; Margins; Capital;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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