How Safe are Central Counterparties in Derivatives Markets?

21 Pages Posted: 10 Nov 2017

See all articles by Mark E. Paddrik

Mark E. Paddrik

Government of the United States of America - Office of Financial Research

Peyton Young

Government of the United States of America - Office of Financial Research; Brookings Institution; University of Oxford

Date Written: November 2, 2017

Abstract

We propose a general framework for estimating the likelihood of default by central counterparties (CCP) in derivatives markets. Unlike conventional stress testing approaches, which estimate the ability of a CCP to withstand nonpayment by its two largest counterparties, we study the direct and indirect effects of nonpayment by members and/or their clients through the full network of exposures. We illustrate the approach for the credit default swaps (CDS) market under shocks that are similar in magnitude to the Federal Reserve’s 2015 Comprehensive Capital Analysis and Review trading book shock. The analysis indicates that conventional stress testing approaches may underestimate the potential vulnerability of the main CCP for this market.

Keywords: Credit Default Swaps, Central Counterparties, Stress Testing, Systemic Risk, Financial Networks

JEL Classification: D85, G01, G17, L14

Suggested Citation

Paddrik, Mark Endel and Young, Peyton, How Safe are Central Counterparties in Derivatives Markets? (November 2, 2017). OFR 17-06, Available at SSRN: https://ssrn.com/abstract=3067589 or http://dx.doi.org/10.2139/ssrn.3067589

Mark Endel Paddrik (Contact Author)

Government of the United States of America - Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

Peyton Young

Government of the United States of America - Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

Brookings Institution

1775 Massachusetts Ave, NW
Washington, DC 20036
United States

University of Oxford

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

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