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A Dynamic Model Of Central Counterparty Risk

Author

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  • TOMASZ R. BIELECKI

    (Department of Applied Mathematics, Illinois Institute of Technology, 10 West 32nd Street, Building REC, Room 208, Chicago, IL 60616, USA)

  • IGOR CIALENCO

    (Department of Applied Mathematics, Illinois Institute of Technology, 10 West 32nd Street, Building REC, Room 208, Chicago, IL 60616, USA)

  • SHIBI FENG

    (Department of Applied Mathematics, Illinois Institute of Technology, 10 West 32nd Street, Building REC, Room 208, Chicago, IL 60616, USA)

Abstract

We introduce a dynamic model of the default waterfall of derivatives central counterparties and propose a risk sensitive method for sizing the initial margin, and the default fund and its allocation among clearing members. Using a Markovian structure model of joint credit migrations, our evaluation of the default fund takes into account the joint credit quality of clearing members as they evolve over time. Another important aspect of the proposed methodology is the use of the time consistent dynamic risk measures for computation of the initial margin and the default fund. We carry out a comprehensive numerical study, where, in particular, we analyze the advantages of the proposed methodology and its comparison with the currently prevailing methods used in industry.

Suggested Citation

  • Tomasz R. Bielecki & Igor Cialenco & Shibi Feng, 2018. "A Dynamic Model Of Central Counterparty Risk," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 21(08), pages 1-34, December.
    • Handle: RePEc:wsi:ijtafx:v:21:y:2018:i:08:n:s0219024918500504
    DOI: 10.1142/S0219024918500504
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    References listed on IDEAS

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    Cited by:

    1. Tomasz R. Bielecki & Igor Cialenco & Marcin Pitera & Thorsten Schmidt, 2019. "Fair Estimation of Capital Risk Allocation," Papers 1902.10044, arXiv.org, revised Nov 2019.

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