Reshaping the Financial Network: Value Redistribution and Externalities in Central Clearing

72 Pages Posted: 7 Jul 2019 Last revised: 18 Jan 2021

See all articles by Olga Briukhova

Olga Briukhova

University of Zurich - Department of Banking and Finance; Swiss Finance Institute

Marco D'Errico

University of Zurich - Department of Banking and Finance

Stefano Battiston

University of Zurich - Department Finance; Ca Foscari University of Venice

Date Written: January 1, 2021

Abstract

The market infrastructure reform carried out in the aftermath of the 2008 financial crisis mandates the central clearing of standardized over-the-counter derivatives. We investigate how this reform can impact on the valuation of derivative contracts and how it can lead to unintended value redistribution effects among market participants. The transition to central clearing changes both the counterparty risk and the funding costs associated with a derivative position. By developing a theoretical model of derivative contract valuation, we clarify how these changes affect the expected value adjustments for a particular dealer and identify the three channels of value redistribution. Moreover, we find that, through these value adjustments, mutualization of risks and collateral in a central clearing counterparty can lead to externalities among the members.

Keywords: Central Clearing Counterparty (CCP), OTC derivatives, financial networks, systemic risk, market structure

JEL Classification: G23, G01, G10

Suggested Citation

Briukhova, Olga and D'Errico, Marco and Battiston, Stefano, Reshaping the Financial Network: Value Redistribution and Externalities in Central Clearing (January 1, 2021). Available at SSRN: https://ssrn.com/abstract=3413844 or http://dx.doi.org/10.2139/ssrn.3413844

Olga Briukhova (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
8032 Zurich
Switzerland
+41446343931 (Phone)

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Marco D'Errico

University of Zurich - Department of Banking and Finance

Plattenstrasse 14
Zürich, 8032
Switzerland

Stefano Battiston

University of Zurich - Department Finance ( email )

Plattenstrasse 32
Zürich, 8032
Switzerland

Ca Foscari University of Venice ( email )

Cannaregio 873
Venice, 30121
Italy

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