A Theory of Collateral Requirements for Central Counterparties

Management Science

59 Pages Posted: 3 Dec 2018 Last revised: 6 Jul 2021

See all articles by Jessie Jiaxu Wang

Jessie Jiaxu Wang

Arizona State University (ASU) - W.P. Carey School of Business

Agostino Capponi

Columbia University

Hongzhong Zhang

Columbia University

Date Written: February 29, 2020

Abstract

This paper develops a framework for designing collateral requirements in a centrally cleared market. Clearing members post collateral—initial margins and default funds—to increase their pledgeable income, thereby committing to risk management. The two types of collateral, however, are not perfect substitutes. By achieving loss mutualization, default funds are economically more efficient than initial margins in aligning members' incentives for risk management ex ante. The optimal mix of collateral resources balances the efficiency in providing incentives with their relative opportunity costs. Our model predicts increased use of initial margins under stringent capital requirements, and of default funds under distressed market scenarios.

Keywords: Central counterparty, collateral, initial margins, default funds, macro-prudential policy

JEL Classification: G18, G23, G28, D82, D62

Suggested Citation

Wang, Jessie Jiaxu and Capponi, Agostino and Zhang, Hongzhong, A Theory of Collateral Requirements for Central Counterparties (February 29, 2020). Management Science, Available at SSRN: https://ssrn.com/abstract=3290397 or http://dx.doi.org/10.2139/ssrn.3290397

Jessie Jiaxu Wang (Contact Author)

Arizona State University (ASU) - W.P. Carey School of Business ( email )

Tempe, AZ 85287-3706
United States

HOME PAGE: http://www.jiaxuwang.com

Agostino Capponi

Columbia University ( email )

S. W. Mudd Building
New York, NY 10027
United States

Hongzhong Zhang

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

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