When Does Portfolio Compression Reduce Systemic Risk?

42 Pages Posted: 10 Sep 2020

See all articles by Luitgard Anna Maria Veraart

Luitgard Anna Maria Veraart

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

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Date Written: September 7, 2020

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 defaults occur among those firms that engage in compression, then portfolio compression always reduces systemic risk.

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

JEL Classification: D85, G01, G28, G33

Suggested Citation

Veraart, Luitgard Anna Maria, When Does Portfolio Compression Reduce Systemic Risk? (September 7, 2020). Available at SSRN: https://ssrn.com/abstract=3688495 or http://dx.doi.org/10.2139/ssrn.3688495

Luitgard Anna Maria 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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