Model Risk at Central Counterparties: Is Skin-in-The-Game a Game Changer?
28 Pages Posted: 2 Jun 2020
Date Written: May 25, 2020
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: Suggested Citation