A Theory of Collateral Requirements for Central Counterparties

57 Pages Posted: 3 Dec 2018 Last revised: 2 Mar 2020

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 new framework for the design of collateral requirements in a centrally cleared market. Clearing members post collateral - initial margins and default funds - to increase their pledgeable income, thereby credibly committing to risk management. We show that initial margins are more cost-effective in aligning members' incentives for risk management. In contrast, default funds are more valuable to enhance the central counterparty's (CCP) resilience by allowing members to mutualize losses. In setting collateral requirements, the CCP balances the opportunity cost of collateral, its effectiveness in providing incentives, and the cost of CCP recapitalization. Our model predicts extensive use of initial margin during normal times, and of default funds under extreme market scenarios.

Keywords: Central counterparty (CCP), collateral requirements, initial margin, default fund, macro-prudential regulation

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). 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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