Counterparty Risk and the Establishment of the New York Stock Exchange Clearinghouse

49 Pages Posted: 21 Jan 2014 Last revised: 13 Aug 2014

See all articles by Asaf Bernstein

Asaf Bernstein

University of Colorado at Boulder; National Bureau of Economic Research (NBER)

Eric N. Hughson

Claremont McKenna College - Robert Day School of Economics and Finance

Marc Weidenmier

Claremont McKenna College - Robert Day School of Economics and Finance; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: August 2014

Abstract

Heightened counterparty risk during the recent financial crisis has raised questions about the role clearinghouses play in global financial stability. Empirical identification of the effect of centralized clearing on counterparty risk is challenging because of the co-incidence of macro-economic turbulence and the introduction of clearinghouses. We overcome these concerns by examining a novel historical experiment, the establishment of a clearinghouse on the New York Stock Exchange (NYSE) in 1892. During this period the largest NYSE stocks were also listed on the Consolidated Stock Exchange (CSE), which already had a clearinghouse. Using identical securities on the CSE as a control, we find that the introduction of clearing reduced annualized volatility of NYSE returns by 90-173bps and increased asset values. Prior to clearing, shocks to overnight lending rates reduced the value of stocks on the NYSE, relative to identical stocks on the CSE, but this was no longer true after the establishment of clearing. We also show that at least ½ of the average reduction in counterparty risk on the NYSE is driven by a reduction in contagion risk – the risk of a cascade of broker defaults. Our results indicate that clearing can cause a significant improvement in market stability and value through a reduction in network contagion and counterparty risk.

Keywords: counterparty risk, central clearing, clearinghouse, contagion, netting

JEL Classification: G12, G18

Suggested Citation

Bernstein, Asaf and Hughson, Eric N. and Weidenmier, Marc D., Counterparty Risk and the Establishment of the New York Stock Exchange Clearinghouse (August 2014). Available at SSRN: https://ssrn.com/abstract=2382379 or http://dx.doi.org/10.2139/ssrn.2382379

Asaf Bernstein (Contact Author)

University of Colorado at Boulder ( email )

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Boulder, CO 80309
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National Bureau of Economic Research (NBER) ( email )

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Eric N. Hughson

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States
909-607-3664 (Phone)

Marc D. Weidenmier

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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