Central Counterparty Capitalization and Misaligned Incentives

54 Pages Posted: 19 Dec 2016

See all articles by Wenqian Huang

Wenqian Huang

Bank for International Settlements

Multiple version iconThere are 2 versions of this paper

Date Written: December 14, 2016

Abstract

Central Counterparties (CCPs) are systemic nodes in financial markets. Incentive regulation on CCPs becomes crucial for financial stability. I investigate incentives and optimal regulation of a profit-driven CCP with limited liability. Conditional on available capital, the CCP fine-tunes collateral requirements to balance fee incomes against counterparty risk. High collateral reduces potential default losses, but leads to foregone profitable trades. Limited liability creates a wedge between the CCP’s collateral policy and the socially optimal solution to this trade-off. However, regulators can use capital requirements to close the wedge, unless clearing fee exceeds a threshold.

Keywords: Central Counterparties (CCPs), Capital Requirement, Collateral

JEL Classification: G01, G12, G21, G22

Suggested Citation

Huang, Wenqian, Central Counterparty Capitalization and Misaligned Incentives (December 14, 2016). Available at SSRN: https://ssrn.com/abstract=2886800 or http://dx.doi.org/10.2139/ssrn.2886800

Wenqian Huang (Contact Author)

Bank for International Settlements ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://wenqianhuang.org

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