Model Risk at Central Counterparties: Is Skin-in-The-Game a Game Changer?

28 Pages Posted: 2 Jun 2020

See all articles by Wenqian Huang

Wenqian Huang

Bank for International Settlements

Előd Takáts

Bank for International Settlements (BIS)

Date Written: May 25, 2020

Abstract

We investigate empirically how the balance sheet characteristics of central counterparties (CCPs) affect their modelling of credit risk. CCPs set initial margin (IM), i.e., the collateral for transactions, to limit counterparty credit risk. When a CCP's IM model fails on a large scale, the CCP could fail too, losing its skin-in-the-game capital. We find that higher skin-in-the-game is significantly associated with more p rudent modelling, in contrast to profits (a proxy for franchise value) and forms of capital other than skin-in-the-game. The results may help to inform the ongoing policy debate on how to incentivise prudent credit risk management at CCPs.

Keywords: central counterparties (CCPs), capital, risk-taking

JEL Classification: F34, F42, G21, G38

Suggested Citation

Huang, Wenqian and Takáts, Előd, Model Risk at Central Counterparties: Is Skin-in-The-Game a Game Changer? (May 25, 2020). BIS Working Paper No. 866, Available at SSRN: https://ssrn.com/abstract=3613194

Wenqian Huang (Contact Author)

Bank for International Settlements ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://wenqianhuang.org

Előd Takáts

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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