Emergence and Future of Central Counterparties

52 Pages Posted: 6 Oct 2010  

Thorsten V. Koeppl

Queen's University - Department of Economics

Cyril Monnet

Federal Reserve Bank of Philadelphia

Date Written: September 1, 2010

Abstract

The authors explain why central counterparties (CCPs) emerged historically. With standardized contracts, it is optimal to insure counterparty risk by clearing those contracts through a CCP that uses novation and mutualization. As netting is not essential for these services, it does not explain why CCPs exist. In over-the-counter markets, as contracts are customized and not fungible, a CCP cannot fully guarantee contract performance. Still, a CCP can help: As bargaining leads to an inefficient allocation of default risk relative to the gains from customization, a transfer scheme is needed. A CCP can implement it by offering partial insurance for customized contracts.

Keywords: Counterparty Risk, Novation, Mutualization, Over-the-counter Markets, Customized Financial Contracts

JEL Classification: G2, G13, D53, D82

Suggested Citation

Koeppl, Thorsten V. and Monnet, Cyril, Emergence and Future of Central Counterparties (September 1, 2010). FRB of Philadelphia Working Paper No. 10-30. Available at SSRN: https://ssrn.com/abstract=1687862 or http://dx.doi.org/10.2139/ssrn.1687862

Thorsten V. Koeppl (Contact Author)

Queen's University - Department of Economics ( email )

99 University Avenue
Kingston K7L 3N6, Ontario
Canada

Cyril Monnet

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

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