Central Counterparty Risk
Matthias Arnsdorf

TL;DR
This paper quantifies the risk faced by financial institutions from their exposure to Central Counterparty (CCP) defaults, modeling loss distributions and incorporating wrong-way risk and contagion effects.
Contribution
It introduces a novel model that explicitly captures CCP risk by modeling member portfolios, capital structure, and loss tail distributions with limited transparency.
Findings
CCP risk for a member is a sum of exposures to other members.
Loss tail modeled with Pareto distribution calibrated to CCP loss probabilities.
Incorporates wrong-way risk and contagion effects explicitly.
Abstract
A clearing member of a Central Counterparty (CCP) is exposed to losses on their default fund and initial margin contributions. Such losses can be incurred whenever the CCP has insufficient funds to unwind the portfolio of a defaulting clearing member. This does not necessarily require the default of the CCP itself. In this note we aim to quantify the risk a financial institution has when facing a CCP. We show that a clearing member's CCP risk is given by a sum of exposures to each of the other clearing members. This arises because of the implicit default insurance that each member has provided in the form of mutualised, loss sharing collateral. We calculate the exposures by explicitly modeling the capital structure of a CCP as well as the loss distributions of the individual member portfolios. An important consideration in designing the model is the limited transparency with respect…
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Taxonomy
TopicsBanking stability, regulation, efficiency · Credit Risk and Financial Regulations · Insurance and Financial Risk Management
