A Macroprudential View on Portfolio Rebalancing and Compression

68 Pages Posted: 8 Jun 2021

See all articles by Luitgard Anna Maria Veraart

Luitgard Anna Maria Veraart

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

Yuliang Zhang

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

Date Written: June 4, 2021

Abstract

We analyse the consequences of post-trade risk reduction services for systemic risk in derivatives markets. Our focus is on portfolio rebalancing, which is a mechanism of injecting new trades to reduce the overall counterparty exposure, and portfolio compression, which is a mechanism to reduce the outstanding notional amount by trades termination and replacement. We first provide a mathematical characterisation of (optimal) portfolio rebalancing. Then, we explore the effects of these services on the financial system from a network perspective by considering contagion arising from only partial repayments in networks of variation margin payments. We provide sufficient conditions for portfolio rebalancing to reduce systemic risk. We also investigate the effects under a scenario where financial institutions react to stress strategically and make delayed payments.

Keywords: Systemic risk, liquidity, post-trade risk reduction, portfolio rebalancing, portfolio compression, multilateral netting

JEL Classification: C62, D85, G01, G28, G33

Suggested Citation

Veraart, Luitgard Anna Maria and Zhang, Yuliang, A Macroprudential View on Portfolio Rebalancing and Compression (June 4, 2021). Available at SSRN: https://ssrn.com/abstract=3860262 or http://dx.doi.org/10.2139/ssrn.3860262

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

Yuliang Zhang

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

Houghton Street
GB-London WC2A 2AE
United Kingdom

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