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Assessing the Safety of Central Counterparties

Author

Listed:
  • Mark Paddrik

    (Office of Financial Research)

  • H. Peyton Young

    (Office of Financial Research)

Abstract

We propose a general framework for empirically assessing a central counterparty's capacity to cope with severe financial stress. Using public disclosure data for global central counterparties (CCPs), we show how to estimate the probability that a CCP could cover any specified fraction of payment defaults by its members. This framework supplements conventional standards of risk management such as Cover 2, and provides a comparative and comprehensive approach to assessing risk protection across CCPs that is not predicated on a specific number of member defaults. We apply the approach to a wide range of CCPs in different geographical jurisdictions and asset classes and find that there are substantial differences in protection coverage. In particular, large European CCPs appear to be significantly safer than their counterparts in Asia-Pacific and North America. These differences are also reflected in supervisory data that provide CCP members' risk assessments of the CCPs to which they belong.

Suggested Citation

  • Mark Paddrik & H. Peyton Young, 2021. "Assessing the Safety of Central Counterparties," Working Papers 21-02, Office of Financial Research, US Department of the Treasury.
    • Handle: RePEc:ofr:wpaper:21-02
    as

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    References listed on IDEAS

    as
    1. Robert Cox & Robert Steigerwald, 2017. "A CCP Is a CCP Is a CCP," Policy Discussion Paper Series 93561, Federal Reserve Bank of Chicago.
    2. Robert A. Jones & Christophe Pérignon, 2013. "Derivatives Clearing, Default Risk, and Insurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 80(2), pages 373-400, June.
    3. Albert J Menkveld, 2017. "Crowded Positions: An Overlooked Systemic Risk for Central Clearing Parties," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 7(2), pages 209-242.
    4. Ghamami, Samim & Paddrik, Mark & Zhang, Simpson, 2023. "Central Counterparty Default Waterfalls and Systemic Loss," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 58(8), pages 3577-3612, December.
    5. Mark Paddrik & Sriram Rajan & H. Peyton Young, 2020. "Contagion in Derivatives Markets," Management Science, INFORMS, vol. 66(8), pages 3603-3616, August.
    6. Murphy, David & Nahai-Williamson, Paul, 2014. "Financial Stability Paper 30: Dear Prudence, won’t you come out to play? Approaches to the analysis of CCP default fund adequacy," Bank of England Financial Stability Papers 30, Bank of England.
    7. Paddrick, Mark & Young, H. Peyton, 2021. "How safe are central counterparties in credit default swap markets?," LSE Research Online Documents on Economics 101170, London School of Economics and Political Science, LSE Library.
    8. Matthias Arnsdorf, 2012. "Central Counterparty Risk," Papers 1205.1533, arXiv.org.
    9. Douglas D. Evanoff & Daniela Russo & Robert Steigerwald, 2006. "Policymakers, researchers, and practitioners discuss the role of central counterparties," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 30(Q IV), pages 2-21.
    10. Paddrick, Mark & Rajan, Sriram & Young, H. Peyton, 2020. "Contagion in derivatives markets," LSE Research Online Documents on Economics 100868, London School of Economics and Political Science, LSE Library.
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    Cited by:

    1. Demange, Gabrielle & Piquard, Thibaut, 2023. "On the choice of central counterparties in the EU," Journal of Financial Markets, Elsevier, vol. 64(C).

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    Keywords

    central counterparty; default waterfall; guarantee fund; default probability;
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