Network effects, cascades and CCP interoperability

Author:

Feng Xiaobing12,Hu Haibo3,Pritsker Matthew4

Affiliation:

1. Shanghai University of International Business and Economics, Shanghai, 201620, P. R. China

2. Shanghai Jiao Tong University, Shanghai, 200240, P. R. China

3. East China University of Science and Technology, Shanghai, 200237, P. R. China

4. Federal Reserve Bank of Boston, Boston, MA 02210, United States

Abstract

To control counterparty risk, financial regulations such as the Dodd Frank Act are increasingly requiring standardized derivatives trades to be cleared by central counterparties (CCPs). It is anticipated that in the near-term future, CCPs across the world will be linked through interoperability agreements that facilitate risk-sharing but also serve as a conduit for transmitting shocks. This paper theoretically studies a network with CCPs that are linked through interoperability arrangements, and studies the properties of the network that contribute to cascading failures. The magnitude of the cascading is theoretically related to the strength of network linkages, the size of the network, the logistic mapping coefficient, a stochastic effect and CCP's defense lines. Simulations indicate that larger network effects increase systemic risk from cascading failures. The size of the network N raises the threshold value of shock sizes that are required to generate cascades. Hence, the larger the network, the more robust it will be.

Publisher

World Scientific Pub Co Pte Lt

Subject

Computational Theory and Mathematics,Computer Science Applications,General Physics and Astronomy,Mathematical Physics,Statistical and Nonlinear Physics

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