When Does Portfolio Compression Reduce Systemic Risk?

45 Pages Posted: 25 Nov 2019

See all articles by Luitgard A. M. Veraart

Luitgard A. M. Veraart

London School of Economics & Political Science (LSE) - Department of Mathematics

Multiple version iconThere are 2 versions of this paper

Date Written: November 16, 2019

Abstract

We analyse the consequences of portfolio compression on systemic risk. Portfolio compression is a post-trading netting mechanism that reduces gross positions while keeping net positions unchanged and it is part of the financial legislation in the US (Dodd-Frank Act) and in Europe (European Market Infrastructure Regulation). We derive necessary structural conditions for portfolio compression to be harmful and discuss policy implications. In particular, we show that the potential danger of portfolio compression comes from defaults of firms that conduct portfolio compression. If no such defaults occur, then portfolio compression weakly reduces systemic risk.

Keywords: systemic risk, portfolio compression, financial networks, cycles, netting

JEL Classification: D85, G01, G28, G33

Suggested Citation

Veraart, Luitgard A. M., When Does Portfolio Compression Reduce Systemic Risk? (November 16, 2019). Available at SSRN: https://ssrn.com/abstract=3488398 or http://dx.doi.org/10.2139/ssrn.3488398

Luitgard A. M. Veraart (Contact Author)

London School of Economics & Political Science (LSE) - Department of Mathematics ( email )

Houghton Street
GB-London WC2A 2AE
United Kingdom

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