Derivatives Clearing, Default Risk, and Insurance
39 Pages Posted: 28 Feb 2008 Last revised: 14 Mar 2013
Date Written: February 1, 2012
Failure of a clearing house would trigger cascade of damaging disruptions throughout the financial system. Yet little is known about the likelihood of such an event. Using daily data on margins and variation margins for all clearing members of the Chicago Mercantile Exchange, we analyze the clearing house exposure to the risk of default by clearing members. We find that the major source of default risk for a clearing member is proprietary trading rather than trading by customers. Additionally, we show that extreme losses suffered by important clearing firms tend to cluster, which raises systemic risk concerns. To quantify its default risk exposure, we characterize the tail risk of the clearing house using Extreme Value Theory. Finally, we discuss how private insurance could be used to cover the loss from defaults by clearing members.
Keywords: Derivatives Exchanges, Clearing House, Default Risk, Systemic Risk
JEL Classification: G13, G18
Suggested Citation: Suggested Citation