Abstract
Abstract
This article analyzes the optimal allocation of losses via a Central Clearing Counterparty (CCP) in the presence of counterparty risk. A CCP can hedge this risk by mutualizing losses among its members. This protection, however, weakens members’ incentives to manage counterparty risk. Delegating members’ risk monitoring to the CCP alleviates this tension in large markets. To discipline the CCP at minimum cost, members offer the CCP a junior tranche and demand capital contribution. Our results endogenize key layers of the default waterfall and deliver novel predictions on its composition, collateral requirements, and CCP ownership structure.
Publisher
Cambridge University Press (CUP)
Subject
Economics and Econometrics,Finance,Accounting
Reference48 articles.
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2. FSB. “Guidance on Financial Resources to Support CCP Resolution and on the Treatment of CCP Equity in Resolution.” Technical Report, Financial Stability Board (2020).
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