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Does a Central Clearing Counterparty Reduce Counterparty Risk?

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Listed:
  • Darrell Duffie
  • Haoxiang Zhu

Abstract

We show whether central clearing of a particular class of derivatives lowers counterparty risk. For plausible cases, adding a central clearing counterparty (CCP) for a class of derivatives such as credit default swaps reduces netting efficiency, leading to an increase in average exposure to counterparty default. Further, clearing different classes of derivatives in separate CCPs always increases counterparty exposures relative to clearing the combined set of derivatives in a single CCP. We provide theory as well as illustrative numerical examples of these results that are calibrated to notional derivatives position data for major banks.

Suggested Citation

  • Darrell Duffie & Haoxiang Zhu, 2011. "Does a Central Clearing Counterparty Reduce Counterparty Risk?," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 1(1), pages 74-95.
    • Handle: RePEc:oup:rasset:v:1:y:2011:i:1:p:74-95.
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    References listed on IDEAS

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    1. Rene M. Stulz, 2010. "Credit Default Swaps and the Credit Crisis," Journal of Economic Perspectives, American Economic Association, vol. 24(1), pages 73-92, Winter.
    2. Theo Lubke & Ada Li & Darrell Duffie, 2010. "Policy perspectives on OTC derivatives market infrastructure," Staff Reports 424, Federal Reserve Bank of New York.
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    More about this item

    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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