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The Failure of a Clearinghouse: Empirical Evidence
[Counterparty risk externality: centralized versus over-the-counter markets]

Author

Listed:
  • Vincent Bignon
  • Guillaume Vuillemey

Abstract

How can we design safe financial institutions, and how should we efficiently resolve them? We study these questions by empirically analyzing the failure of a derivatives central clearing counterparty (CCP) in Paris in 1974. First, we identify the risk management failures that caused the default and draw implications for CCP design. Second, we show evidence of new agency problems arising when supervisors have discretionary powers over debt restructuring for a failed entity. These conflicts, between managers and the supervisor (misreporting), as well as between managers and creditors (risk-shifting), are difficult to mitigate with regulation or covenants. Their existence has implications for the design of recovery and resolution rules for financial institutions.

Suggested Citation

  • Vincent Bignon & Guillaume Vuillemey, 2020. "The Failure of a Clearinghouse: Empirical Evidence [Counterparty risk externality: centralized versus over-the-counter markets]," Review of Finance, European Finance Association, vol. 24(1), pages 99-128.
    • Handle: RePEc:oup:revfin:v:24:y:2020:i:1:p:99-128.
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    More about this item

    Keywords

    Central clearing; Resolution; Financial distress; Risk-shifting;
    All these keywords.

    JEL classification:

    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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