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Central Counterparty Default Waterfalls and Systemic Loss

Author

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  • Mark Paddrik

    (Office of Financial Research)

  • Simpson Zhang

    (Office of the Comptroller of the Currency)

Abstract

Central counterparty default waterfalls act as last lines of defense in over-the-counter markets by managing and allocating resources to cover defaults of clearing members and clients. However, central counterparties face competing objectives in setting up their default waterfalls. In this paper we evaluate the trade-offs between default waterfall resiliency and central clearing, using a unique and comprehensive dataset containing all U.S. cleared and bilateral credit default swap positions. We evaluate the resiliency of different default waterfall designs, accounting for the interconnectedness of payments in the system, the presence of client clearing obligations for members, and the distribution of losses among market participants.

Suggested Citation

  • Mark Paddrik & Simpson Zhang, 2020. "Central Counterparty Default Waterfalls and Systemic Loss," Working Papers 20-04, Office of Financial Research, US Department of the Treasury.
    • Handle: RePEc:ofr:wpaper:20-04
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    References listed on IDEAS

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    Cited by:

    1. Viral V. Acharya & Aaditya M. Iyer & Rangarajan K. Sundaram, 2020. "Risk-Sharing and the Creation of Systemic Risk," JRFM, MDPI, vol. 13(8), pages 1-38, August.
    2. Mark Paddrik & H. Peyton Young, 2021. "Assessing the Safety of Central Counterparties," Working Papers 21-02, Office of Financial Research, US Department of the Treasury.
    3. Jessie Jiaxu Wang & Agostino Capponi & Hongzhong Zhang, 2022. "A Theory of Collateral Requirements for Central Counterparties," Management Science, INFORMS, vol. 68(9), pages 6993-7017, September.
    4. Jin-Wook Chang, 2019. "Collateralized Debt Networks with Lender Default," Finance and Economics Discussion Series 2019-083, Board of Governors of the Federal Reserve System (U.S.).

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    More about this item

    Keywords

    central counterparty; systemic risk; default waterfall; financial networks; credit default swaps;
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