Market structure, counterparty risk, and systemic risk
AbstractNetworks modeling bilaterally-cleared and centrally-cleared derivatives markets are shown to yield economically different price impact, volatility and contagion after an initial bankruptcy. A large bankruptcy in bilateral markets may leave a counterparty unable to expectationally prevent bankruptcy (checkmate) or make counterparties push markets and profit from contagion (hunting). In distress, bilateral markets amplify systemic risk and volatility versus centralized markets and are more subject to crises with real effects: contagion, unemployment, reduced tax revenue, higher transactions costs, lower risk sharing, and reduced allocative efficiency. Pricing distress volatility may suggest when to transition to central clearing. The model suggests three metrics for the well-connected part of a market -- number of counterparties, average risk aversion, and standard deviation of total exposure -- may characterize its fragility.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 36786.
Date of creation: 10 Jun 2009
Date of revision: 19 Dec 2011
network model; systemic risk; contagion; predatory trading;
Find related papers by JEL classification:
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
- G01 - Financial Economics - - General - - - Financial Crises
- D49 - Microeconomics - - Market Structure and Pricing - - - Other
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