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What Happens when Peter can't Pay Paul: Risk Management at Futures Exchange Clearinghouses

  • Shi, Wei
  • Irwin, Scott H.

We model a futures exchange's clearinghouse as a "bank" holding a portfolio of credit lines available to its clearing members and collateralized with clearing margins or, equivalently, a portfolio of short European put basket options. Consequently, the "bank" model measures the clearinghouse's risk exposure as the sum of the payoff functions of these put options, emphasizing the portfolio diversification and the option-like payoffs. The model is used to assess exchange's clearinghouse's liquidity and credit risk exposure. The model provides exchange clearinghouses and government regulators with a theoretical framework of risk management that systematically integrates clearing margin requirements,credit lines and economic capital.

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File URL: http://purl.umn.edu/21087
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Paper provided by American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association) in its series 2006 Annual meeting, July 23-26, Long Beach, CA with number 21087.

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Date of creation: 2006
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Handle: RePEc:ags:aaea06:21087
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  1. Michael B. Gordy, 1998. "A comparative anatomy of credit risk models," Finance and Economics Discussion Series 1998-47, Board of Governors of the Federal Reserve System (U.S.).
  2. Bates, David & Craine, Roger, 1999. "Valuing the Futures Market Clearinghouse's Default Exposure during the 1987 Crash," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(2), pages 248-72, May.
  3. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-51.
  4. Hans Dewachter & Geert Gielens, 1999. "Setting futures margins: the extremes approach," Applied Financial Economics, Taylor & Francis Journals, vol. 9(2), pages 173-181.
  5. Paul H. Kupiec, 1997. "Margin Requirements, Volatility, and Market Integrity: What Have We Learned Since The Crash?," FMG Special Papers sp97, Financial Markets Group.
  6. Theodore E. Day, 2004. "Margin Adequacy and Standards: An Analysis of the Crude Oil Futures Market," The Journal of Business, University of Chicago Press, vol. 77(1), pages 101-136, January.
  7. G. Geoffrey Booth & John Paul Broussard & Teppo Martikainen & Vesa Puttonen, 1997. "Prudent Margin Levels in the Finnish Stock Index Futures Market," Management Science, INFORMS, vol. 43(8), pages 1177-1188, August.
  8. Cotter, John, 2001. "Margin exceedences for European stock index futures using extreme value theory," Journal of Banking & Finance, Elsevier, vol. 25(8), pages 1475-1502, August.
  9. Longin, Francois M., 2000. "From value at risk to stress testing: The extreme value approach," Journal of Banking & Finance, Elsevier, vol. 24(7), pages 1097-1130, July.
  10. Day, Theodore E & Lewis, Craig M, 1997. "Initial Margin Policy and Stochastic Volatility in the Crude Oil Futures Market," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 303-32.
  11. Gemmill, Gordon, 1994. "Margins and the safety of clearing houses," Journal of Banking & Finance, Elsevier, vol. 18(5), pages 979-996, October.
  12. Paul H. Kupiec & A. Patricia White, 1996. "Regulatory competition and the efficiency of alternative derivative product margining systems," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 16(8), pages 943-968, December.
  13. Paul H. Kupiec & A. Patricia White, 1996. "Regulatory competition and the efficiency of alternative derivative product margining systems," Finance and Economics Discussion Series 96-11, Board of Governors of the Federal Reserve System (U.S.).
  14. S. Illeris & G. Akehurst, 2002. "Introduction," The Service Industries Journal, Taylor & Francis Journals, vol. 22(1), pages 1-3, January.
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