Central Clearing of OTC Derivatives: Bilateral vs Multilateral Netting

19 Pages Posted: 6 Sep 2012

See all articles by Rama Cont

Rama Cont

University of Oxford; CNRS

Thomas Kokholm

School of Business and Social Sciences, Aarhus University

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2012

Abstract

We study the impact of central clearing of over-the-counter (OTC) transactions on counterparty exposures in a market with OTC transactions across several asset classes with heterogeneous characteristics. We find that the impact, on total expected interdealer exposure, of introducing a central counterparty (CCP) for a single class of OTC derivatives is sensitive to assumptions on heterogeneity of asset classes in terms of `riskyness' of the asset class as well as correlation of exposures across asset classes. In particular, while an analysis assuming independent, homogeneous exposures suggests that central clearing is efficient only if one has an unrealistically high number of participants, the opposite conclusion is reached if differences in riskyness and correlation across asset classes are realistically taken into account. Empirically plausible specifications of these parameters lead to the conclusion that the gain from multilateral netting in a CCP overweighs the loss of netting across asset classes in bilateral netting agreements. When a CCP exists for interest rate derivatives, adding a CCP for credit derivatives is shown to decrease overall exposures. These findings are shown to be robust to the choice of distribution for OTC derivatives exposures.

Suggested Citation

Cont, Rama and Kokholm, Thomas, Central Clearing of OTC Derivatives: Bilateral vs Multilateral Netting (September 1, 2012). Midwest Finance Association 2013 Annual Meeting Paper. Available at SSRN: https://ssrn.com/abstract=2140055 or http://dx.doi.org/10.2139/ssrn.2140055

Rama Cont

University of Oxford ( email )

Mathematical Institute
Oxford, OX2 6GG
United Kingdom

HOME PAGE: http://https://www.maths.ox.ac.uk/people/rama.cont

CNRS ( email )

LPSM
Sorbonne University
Paris
France

HOME PAGE: http://rama.cont.perso.math.cnrs.fr/

Thomas Kokholm (Contact Author)

School of Business and Social Sciences, Aarhus University ( email )

Fuglesangs Allé 4
Aarhus, DK-8210
Denmark

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