Counterparty Credit Limits: The Impact of a Risk-Mitigation Measure on Everyday Trading

29 Pages Posted: 27 Sep 2017 Last revised: 23 Jan 2021

See all articles by Martin Gould

Martin Gould

University of Oxford - Mathematical Institute

Nikolaus Hautsch

University of Vienna - Department of Statistics and Operations Research; Center for Financial Studies (CFS); Vienna Graduate School of Finance (VGSF)

Sam Howison

University of Oxford - Nomura Centre for Quantitative Finance, OCIAM

Mason A. Porter

California Institute of Technology

Date Written: January 22, 2021

Abstract

A counterparty credit limit (CCL) is a limit that is imposed by a financial institution to cap its maximum possible exposure to a specified counterparty. CCLs help institutions to mitigate counterparty credit risk via selective diversification of their exposures. In this paper, we analyze how CCLs impact the prices that institutions pay for their trades during everyday trading. We study a high-quality data set from a large electronic trading platform in the foreign exchange spot market, which enables institutions to apply CCLs. We find empirically that CCLs had little impact on the vast majority of trades in this data. We also study the impact of CCLs using a new model of trading. By simulating our model with different underlying CCL networks, we highlight that CCLs can have a major impact in some situations.

Keywords: Counterparty Credit Limits; Counterparty Credit Risk; Price Formation; Market Design; Foreign Exchange

Suggested Citation

Gould, Martin and Hautsch, Nikolaus and Howison, Sam and Porter, Mason A., Counterparty Credit Limits: The Impact of a Risk-Mitigation Measure on Everyday Trading (January 22, 2021). CFS Working Paper, WP No. 581, Available at SSRN: https://ssrn.com/abstract=3043112 or http://dx.doi.org/10.2139/ssrn.3043112

Martin Gould

University of Oxford - Mathematical Institute ( email )

Andrew Wiles Building
Radcliffe Observatory Quarter (550)
Oxford, OX2 6GG
United Kingdom

Nikolaus Hautsch (Contact Author)

University of Vienna - Department of Statistics and Operations Research ( email )

Kolingasse 14
Vienna, A-1090
Austria

Center for Financial Studies (CFS) ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Vienna Graduate School of Finance (VGSF) ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

Sam Howison

University of Oxford - Nomura Centre for Quantitative Finance, OCIAM ( email )

Mathematical Institute
24-29 St Giles
Oxford OX1 3LB
United Kingdom

Mason A. Porter

California Institute of Technology ( email )

Pasadena, CA 91125
United States

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