Pitfalls of Central Clearing in the Presence of Systematic Risk

79 Pages Posted: 6 Nov 2018 Last revised: 17 Sep 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: September 14, 2019

Abstract

Through the lens of market participants' objective to minimize counterparty risk, we investigate central clearing in derivatives markets, and its interaction with systematic risk, portfolio directionality, and loss sharing. Previous studies suggest that central clearing always reduces counterparty risk for a sufficiently large number of clearing members. We show that this is not the case - mostly because of loss sharing. Central clearing can increase counterparty risk, particularly during extreme market events, for traders with directional portfolios, and because CCPs mutualize default losses. Our results are consistent with the reluctance to clear derivative trades in the absence of a clearing obligation.

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, Pitfalls of Central Clearing in the Presence of Systematic Risk (September 14, 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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