Derivatives and systemic risk: netting, collateral, and closeout
AbstractIn 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.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-05-03.
Date of creation: 2005
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-07-11 (All new papers)
- NEP-CFN-2005-07-11 (Corporate Finance)
- NEP-REG-2005-07-11 (Regulation)
- NEP-RMG-2005-07-11 (Risk Management)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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