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Network effects, cascades and CCP interoperability

Author

Listed:
  • Xiaobing Feng

    (Shanghai University of International Business and Economics, Shanghai, 201620, P. R. China;
    Shanghai Jiao Tong University, Shanghai, 200240, P. R. China)

  • Haibo Hu

    (East China University of Science and Technology, Shanghai, 200237, P. R. China)

  • Matthew Pritsker

    (Federal Reserve Bank of Boston, Boston, MA 02210, United States)

Abstract

To control counterparty risk, financial regulations such as the Dodd Frank Act are increasingly requiring standardized derivatives trades to be cleared by central counterparties (CCPs). It is anticipated that in the near-term future, CCPs across the world will be linked through interoperability agreements that facilitate risk-sharing but also serve as a conduit for transmitting shocks. This paper theoretically studies a network with CCPs that are linked through interoperability arrangements, and studies the properties of the network that contribute to cascading failures. The magnitude of the cascading is theoretically related to the strength of network linkages, the size of the network, the logistic mapping coefficient, a stochastic effect and CCP's defense lines. Simulations indicate that larger network effects increase systemic risk from cascading failures. The size of the networkNraises the threshold value of shock sizes that are required to generate cascades. Hence, the larger the network, the more robust it will be.

Suggested Citation

  • Xiaobing Feng & Haibo Hu & Matthew Pritsker, 2014. "Network effects, cascades and CCP interoperability," International Journal of Modern Physics C (IJMPC), World Scientific Publishing Co. Pte. Ltd., vol. 25(09), pages 1-13.
    • Handle: RePEc:wsi:ijmpcx:v:25:y:2014:i:09:n:s0129183114500351
    DOI: 10.1142/S0129183114500351
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    References listed on IDEAS

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    1. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2010. "Cascades in Networks and Aggregate Volatility," NBER Working Papers 16516, National Bureau of Economic Research, Inc.
    2. John P Jackson & Mark J Manning, 2007. "Comparing the pre-settlement risk implications of alternative clearing arrangements," Bank of England working papers 321, Bank of England.
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    Cited by:

    1. Berndsen, Ron, 2020. "Five Fundamental Questions on Central Counterparties," Other publications TiSEM 1f3bd844-92ab-4104-8f57-9, Tilburg University, School of Economics and Management.

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