• Selected
• Entire List

Abstract:
We show whether the introduction of a central clearing counterparty (CCP) for a particular asset class, such as credit derivatives, improves the efficiency of counterparty risk mitigation and collateral demands, relative to bilateral netting between pairs of dealers. We show that, for plausible cases, adding a CCP for one class of derivatives such as credit default swaps (CDS) can actually reduce netting efficiency and thereby lead to an increase in collateral demands and average exposure to counterparty default. We also show that whenever it is efficient to introduce a central clearing counterparty, it cannot be efficient to introduce more than one CCP for the same class of derivatives.

counterparty risk, central clearing, over-the-counter market, financial intermediary, market efficiency

Abstract:
This paper shows that, within any Gaussian dynamic term structure model (GDTSM), the historical distribution of the pricing factors P is invariant to the imposition of no-arbitrage restrictions, as well as to additional constraints that impinge only on the risk-neutral dynamics of P. It follows that, in these settings, GDTSM-implied forecasts of future values of P are identical to those from an unrestricted vector autoregressive model of P. To establish these results, we develop a novel canonical GDTSM in which the pricing factors are observable portfolios of yields. For our normalization, standard maximum likelihood algorithms converge to the global optimum almost instantaneously. We also extend our analysis to GDTSMs with reduced-rank risk premiums and to those with macroeconomic variables as pricing factors. Empirical estimates and out-of-sample forecasting results are presented for several GDTSMs using data on U.S. Treasury bond yields.

Dynamic term structure model, gaussian, estimation