Does a Central Clearing Counterparty Reduce Counterparty Risk?
Stanford University - Graduate School of Business; National Bureau of Economic Research (NBER)
Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)
April 27, 2011
Rock Center for Corporate Governance at Stanford University Working Paper No. 46
Stanford University Graduate School of Business Research Paper No. 2022
We show whether central clearing of a particular class of derivatives lowers counterparty risk. For plausible cases, adding a central clearing counterparty (CCP) for a class of derivatives such as credit default swaps reduces netting efficiency, leading to an increase in average exposure to counterparty default. Further, clearing different classes of derivatives in separate CCPs always increases counterparty exposures relative to clearing the combined set of derivatives in a single CCP. We provide theory as well as illustrative numerical examples of these results that are calibrated to notional derivatives position data for major banks.
Number of Pages in PDF File: 31
Keywords: central clearing, netting efficiency, counterparty risk, over-the-counter derivatives
JEL Classification: G01, G14, G18, G28
Date posted: February 23, 2009 ; Last revised: April 28, 2011