CDS Central Counterparty Clearing Default Measures: Road to Recovery or Invitation to Predation?

75 Pages Posted: 12 Nov 2020 Last revised: 27 Nov 2020

See all articles by Magdalena Tywoniuk

Magdalena Tywoniuk

Swiss Finance Institute, Students; University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute, Students

Date Written: August 1, 2020

Abstract

Following the 2008 financial crisis, regulation mandates the clearing of the CDS market through Central Clearing Counter-parties (CCPs). Large CCPs are now designated as ’Global Systemically Important Institutions’ (GSIIs), whose unlikely-but-plausible failure threatens global financial market stability. This work examines CCP resilience following a large dealer member’s default and the ensuing default contagion. In unwinding the defaulter’s positions, the CCP faces the price impact of constrained member liquidations and unconstrained members’ predatory selling. The variation margin captures the effect of price-mediated contagion and its amplification. A novel spatial measure captures the covariance between members’ CDS holdings and the CDS being unwound. Key results show: Liquidations by constrained members lower the CCP’s profits and make cds-spreads less informative. There exists a strong conflict between predatory competition and dealer distress, which inadvertently makes dealers prey on themselves. In turn, the adoption of a risk-sharing guarantee fund structure would provide a natural disciplinary mechanism for predation – minimizing overall CCP and member losses. A dynamic simulation, calibrated to OTC market data, supports these theoretical results with parameter magnitudes and sensitivities. Examination of three market liquidity scenarios provides intuition for effective liquidity injection by a Lender of Last Resort.

Keywords: Systemic Risk, CCP Recovery, CDS, CDS Spread Fire Sales, Liquidation, Predation, Price Impact, Contagion, Financial Network, Over the Counter Markets

JEL Classification: G00, G01, G02, G14, G10, G18, G20, G23, G33

Suggested Citation

Tywoniuk, Magdalena, CDS Central Counterparty Clearing Default Measures: Road to Recovery or Invitation to Predation? (August 1, 2020). Swiss Finance Institute Research Paper No. 20-95, Available at SSRN: https://ssrn.com/abstract=3698300 or http://dx.doi.org/10.2139/ssrn.3698300

Magdalena Tywoniuk (Contact Author)

Swiss Finance Institute, Students ( email )

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

HOME PAGE: http://https://pasdedanseuse.wixsite.com/magdalenatywoniuk

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

Geneva, Geneva
Switzerland

HOME PAGE: http://https://pasdedanseuse.wixsite.com/magdalenatywoniuk

Swiss Finance Institute, Students ( email )

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

HOME PAGE: http://https://pasdedanseuse.wixsite.com/magdalenatywoniuk

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
61
Abstract Views
413
Rank
525,508
PlumX Metrics