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Stress Testing Networks: The Case of Central Counterparties

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  • Richard B. Berner
  • Stephen G. Cecchetti
  • Kermit L. Schoenholtz

Abstract

Stress tests applied to individual institutions are an important tool for evaluating financial resilience. However, financial systems are typically complex, heterogeneous and rapidly changing, raising questions about the adequacy of conventional tests. In this paper, we interpret the current stress test practice from a network perspective, highlighting central counterparties (CCPs) as an example of a critical network hub. Networks that include CCPs involve deep and broad interconnections, making stress testing a challenging task. We analyze supplementing both private and supervisory CCP stress tests with a high-frequency indicator constructed from a market-based estimate of the conditional capital shortfall (SRISK) of the CCP’s clearing members. Applying our measure to two large CCPs, we analyze how they can transmit and amplify shocks across borders, conditional on the exhaustion of prefunded resources. Our results highlight how the network created by central clearing can act as an important transmission mechanism for shocks emanating from Europe.

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  • Richard B. Berner & Stephen G. Cecchetti & Kermit L. Schoenholtz, 2019. "Stress Testing Networks: The Case of Central Counterparties," NBER Working Papers 25686, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:25686
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    1. Cecchetti, Stephen & Berner, Richard & Schoenholtz, Kermit L., 2019. "Stress Testing Networks: The Case of Central Counterparties," CEPR Discussion Papers 13604, C.E.P.R. Discussion Papers.

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    More about this item

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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