Stress Testing Networks: The Case of Central Counterparties

31 Pages Posted: 26 Mar 2019

See all articles by Richard Berner

Richard Berner

Leonard N. Stern School of Business, NYU

Stephen G. Cecchetti

Brandeis International Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Kermit Schoenholtz

New York University (NYU) - Leonard N. Stern School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: March 2019

Abstract

Stress tests applied to individual institutions are an important tool for evaluating financial resilience. However, financial systems are typically complex, heterogeneous and rapidly changing, raising questions about the adequacy of conventional tests. In this paper, we interpret the current stress test practice from a network perspective, highlighting central counterparties (CCPs) as an example of a critical network hub. Networks that include CCPs involve deep and broad interconnections, making stress testing a challenging task. We analyze supplementing both private and supervisory CCP stress tests with a high-frequency indicator constructed from a market-based estimate of the conditional capital shortfall (SRISK) of the CCP’s clearing members. Applying our measure to two large CCPs, we analyze how they can transmit and amplify shocks across borders, conditional on the exhaustion of prefunded resources. Our results highlight how the network created by central clearing can act as an important transmission mechanism for shocks emanating from Europe.

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Suggested Citation

Berner, Richard and Cecchetti, Stephen G. and Schoenholtz, Kermit, Stress Testing Networks: The Case of Central Counterparties (March 2019). NBER Working Paper No. w25686. Available at SSRN: https://ssrn.com/abstract=3359486

Richard Berner (Contact Author)

Leonard N. Stern School of Business, NYU ( email )

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Stephen G. Cecchetti

Brandeis International Business School ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Kermit Schoenholtz

New York University (NYU) - Leonard N. Stern School of Business ( email )

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New York, NY
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