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Derivatives and Systemic Risk: Netting, Collateral, and Closeout

Robert R. Bliss

Wake Forest University - Schools of Business

George G. Kaufman

Loyola University Chicago

May 10, 2005

FRB of Chicago Working Paper No. 2005-03

In the U.S., as in most countries with well-developed securities markets, derivative securities enjoy special protections under insolvency resolution laws. Most creditors are "stayed" from enforcing their rights while a firm is in bankruptcy. However, many derivatives contracts are exempt from these stays. Furthermore, derivatives enjoy netting and close-out, or termination, privileges which are not always available to most other creditors. The primary argument used to motivate passage of legislation granting these extraordinary protections is that derivatives markets are a major source of systemic risk in financial markets and that netting and close-out reduce this risk. To date, these assertions have not been subjected to rigorous economic scrutiny. This paper critically reexamines this hypothesis. These relationships are more complex than often perceived. We conclude that it is not clear whether netting, collateral, and/or close-out lead to reduced systemic risk, once the impact of these protections on the size and structure of the derivatives market has been taken into account.

Number of Pages in PDF File: 34

Keywords: systemic risk, derivatives, close-out netting

JEL Classification: G18, G28, G33

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Date posted: May 28, 2005  

Suggested Citation

Bliss, Robert R. and Kaufman, George G., Derivatives and Systemic Risk: Netting, Collateral, and Closeout (May 10, 2005). FRB of Chicago Working Paper No. 2005-03. Available at SSRN: http://ssrn.com/abstract=730648 or http://dx.doi.org/10.2139/ssrn.730648

Contact Information

Robert R. Bliss (Contact Author)
Wake Forest University - Schools of Business ( email )
P.O. Box 7659
Winston-Salem, NC 27109-7285
United States
336-758-5957 (Phone)
336-758-6133 (Fax)
George G. Kaufman
Loyola University Chicago ( email )
820 North Michigan Avenue
School of Business
Chicago, IL 60611
United States
312-915-7075 (Phone)
312-915-8508 (Fax)
HOME PAGE: http://www.luc.edu/faculty/gkaufma/
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