The pitfalls of central clearing in the presence of systematic risk

Arbeitspapier

Through the lens of market participants' objective to minimize counterparty risk, we provide an explanation for the reluctance to clear derivative trades in the absence of a central clearing obligation. We develop a comprehensive understanding of the benefits and potential pitfalls with respect to a single market participant's counterparty risk exposure when moving from a bilateral to a clearing architecture for derivative markets. Previous studies suggest that central clearing is beneficial for single market participants in the presence of a sufficiently large number of clearing members. We show that three elements can render central clearing harmful for a market participant's counterparty risk exposure regardless of the number of its counterparties: 1) correlation across and within derivative classes (i.e., systematic risk), 2) collateralization of derivative claims, and 3) loss sharing among clearing members. Our results have substantial implications for the design of derivatives markets, and highlight that recent central clearing reforms might not incentivize market participants to clear derivatives.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ICIR Working Paper Series ; No. 31/18

Classification and Topics

• Classification: Wirtschaft ; Financial Crises ; Information and Market Efficiency; Event Studies; Insider Trading ; General Financial Markets: Government Policy and Regulation ; Financial Institutions and Services: Government Policy and Regulation
• Subject: Central Clearing ; Counterparty Risk ; Systematic Risk ; OTC markets ; Derivatives ; Loss Sharing ; Collateral ; Margin

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Kubitza, Christian ; Pelizzon, Loriana ; Getmansky, Mila
• Event: Veröffentlichung
• (who): Goethe University Frankfurt, International Center for Insurance Regulation (ICIR)
• (where): Frankfurt a. M.
• (when): 2018

Further information

• Handle: http://hdl.handle.net/10419/187431
• Last update: 10.03.2025, 11:45 AM CET