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Model risk at central counterparties: is skin in the game a game changer?

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  • Huang, Wenqian
  • Takáts, Előd

Abstract

As central counterparties (CCPs) have become systemic, their credit risk modeling has become critical for the global financial system. This paper empirically investigates CCPs’ incentives to model credit risk. Our hypothesis is that the more CCPs stand to lose from mismanagement, the more conservatively they model credit risk. Accordingly, we find that the higher the skin in the game, i.e., the CCP capital dedicated to credit risk, the lower the model risk is. The results are significant and robust across different model risk proxies. Consistent with our hypothesis, the association with other forms of capital is not significant. Our findings inform the policy debate on CCP capital regulation.

Suggested Citation

  • Huang, Wenqian & Takáts, Előd, 2024. "Model risk at central counterparties: is skin in the game a game changer?," LSE Research Online Documents on Economics 124360, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:124360
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    Cited by:

    1. Evangelos Benos & Gerardo Ferrara & Angelo Ranaldo, 2022. "Collateral Cycles," Swiss Finance Institute Research Paper Series 22-91, Swiss Finance Institute.
    2. Inaki Aldasoro & Luitgard A M Veraart, 2022. "Systemic Risk in Markets with Multiple Central Counterparties," BIS Working Papers 1052, Bank for International Settlements.
    3. Boudiaf, Ismael Alexander & Scheicher, Martin & Vacirca, Francesco, 2023. "CCP initial margin models in Europe," Occasional Paper Series 314, European Central Bank.
    4. Melinda Friesz & Kira Muratov-Szabó & Andrea Prepuk & Kata Váradi, 2021. "Risk Mutualization in Central Clearing: An Answer to the Cross-Guarantee Phenomenon from the Financial Stability Viewpoint," Risks, MDPI, vol. 9(8), pages 1-19, August.
    5. Grothe, Magdalena & Pancost, N. Aaron & Tompaidis, Stathis, 2023. "Collateral competition: Evidence from central counterparties," Journal of Financial Economics, Elsevier, vol. 149(3), pages 536-556.

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    More about this item

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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