34 Pages Posted: 28 May 2005
Date Written: May 10, 2005
In the U.S., as in most countries with well-developed securities markets, derivative securities enjoy special protections under insolvency resolution laws. Most creditors are "stayed" from enforcing their rights while a firm is in bankruptcy. However, many derivatives contracts are exempt from these stays. Furthermore, derivatives enjoy netting and close-out, or termination, privileges which are not always available to most other creditors. The primary argument used to motivate passage of legislation granting these extraordinary protections is that derivatives markets are a major source of systemic risk in financial markets and that netting and close-out reduce this risk. To date, these assertions have not been subjected to rigorous economic scrutiny. This paper critically reexamines this hypothesis. These relationships are more complex than often perceived. We conclude that it is not clear whether netting, collateral, and/or close-out lead to reduced systemic risk, once the impact of these protections on the size and structure of the derivatives market has been taken into account.
Keywords: systemic risk, derivatives, close-out netting
JEL Classification: G18, G28, G33
Suggested Citation: Suggested Citation
Bliss, Robert R. and Kaufman, George G., Derivatives and Systemic Risk: Netting, Collateral, and Closeout (May 10, 2005). FRB of Chicago Working Paper No. 2005-03. Available at SSRN: https://ssrn.com/abstract=730648 or http://dx.doi.org/10.2139/ssrn.730648