52 Pages Posted: 6 Oct 2010
Date Written: September 1, 2010
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: 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