The Pitfalls of Central Clearing in the Presence of Systematic Risk

54 Pages Posted: 6 Nov 2018 Last revised: 22 May 2019

See all articles by Christian Kubitza

Christian Kubitza

University of Bonn - Institute for Financial Economics and Statistics

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration; Goethe University Frankfurt - Research Center SAFE; Ca Foscari University of Venice

Mila Getmansky Sherman

University of Massachusetts at Amherst - Eugene M. Isenberg School of Management - Department of Finance

Date Written: May 20, 2019

Abstract

Through the lens of market participants' objective to minimize counterparty risk exposure, we show that central clearing is not the optimal choice in various realistic situations. Previous studies suggest that central clearing is beneficial in the presence of a reasonable number of clearing members. We show that this is typically not the case by explicitly considering systematic risk in derivative prices. Central clearing increases counterparty risk exposure particularly in cases of extreme events, small clearing margins, and directionality (i.e., nonzero net positions) in derivative portfolios. Our results are consistent with market participants' reluctance to clear derivative trades in the absence of a clearing obligation and have substantial implications for derivatives market design.

Keywords: Central Clearing, Counterparty Risk, Systematic Risk, OTC markets, Derivatives, Margin

JEL Classification: G01, G14, G18, G28

Suggested Citation

Kubitza, Christian and Pelizzon, Loriana and Getmansky Sherman, Mila, The Pitfalls of Central Clearing in the Presence of Systematic Risk (May 20, 2019). SAFE Working Paper No. 235. Available at SSRN: https://ssrn.com/abstract=3278582 or http://dx.doi.org/10.2139/ssrn.3278582

Christian Kubitza

University of Bonn - Institute for Financial Economics and Statistics ( email )

Regina-Pacis-Weg 3
Postfach 2220
Bonn, D-53012
Germany

Loriana Pelizzon (Contact Author)

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, D-60323
Germany

Goethe University Frankfurt - Research Center SAFE ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

HOME PAGE: http://www.safe-frankfurt.de

Ca Foscari University of Venice ( email )

Dorsoduro 3246
Venice, Veneto 30123
Italy

Mila Getmansky Sherman

University of Massachusetts at Amherst - Eugene M. Isenberg School of Management - Department of Finance ( email )

Amherst, MA 01003-4910
United States

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