Central clearing of OTC derivatives: Bilateral vs multilateral netting
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Rama Cont
Rama ContDepartment of Mathematics & Institute of Quantititive Finance, Imperial College, London SW8 2AZ, United KingdomSearch for this author in:
and Thomas Kokholm
Thomas KokholmDepartment of Economics and Business, Aarhus University, Fuglesangs Allé 4, 8210 Aarhus, DenmarkSearch for this author in:
Abstract
We study the impact of central clearing of over-the-counter (OTC) transactions on counterparty exposures in a market with OTC transactions across several asset classes with heterogeneous characteristics. The impact of introducing a central counterparty (CCP) on expected interdealer exposure is determined by the tradeoff between multilateral netting across dealers on one hand and bilateral netting across asset classes on the other hand. We find this tradeoff to be sensitive to assumptions on heterogeneity of asset classes in terms of `riskyness' of the asset class as well as correlation of exposures across asset classes. In particular, while an analysis assuming independent, homogeneous exposures suggests that central clearing is efficient only if one has an unrealistically high number of participants, the opposite conclusion is reached if differences in riskyness and correlation across asset classes are realistically taken into account. We argue that empirically plausible specifications of model parameters lead to the conclusion that central clearing does reduce interdealer exposures: the gain from multilateral netting in a CCP overweighs the loss of netting across asset classes in bilateral netting agreements. When a CCP exists for interest rate derivatives, adding a CCP for credit derivatives is shown to decrease overall exposures. These findings are shown to be robust to the statistical assumptions of the model as well as the choice of risk measure used to quantify exposures.
©2014 Walter de Gruyter Berlin/Boston
Articles in the same Issue
- Frontmatter
- Special Issue on Systemic Risk
- Foreword
- Central clearing of OTC derivatives: Bilateral vs multilateral netting
- Optimal control of interbank contagion under complete information
- On dependence consistency of CoVaRand some other systemic risk measures
- Spatial risk measures and their local specification: The locally law-invariant case
- Complete duality for quasiconvex dynamic risk measures on modules of the Lp-type
Articles in the same Issue
- Frontmatter
- Special Issue on Systemic Risk
- Foreword
- Central clearing of OTC derivatives: Bilateral vs multilateral netting
- Optimal control of interbank contagion under complete information
- On dependence consistency of CoVaRand some other systemic risk measures
- Spatial risk measures and their local specification: The locally law-invariant case
- Complete duality for quasiconvex dynamic risk measures on modules of the Lp-type