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To Share or Not to Share? Uncovered Losses in a Derivatives Clearinghouse

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  • Radoslav Raykov

Abstract

This paper studies how the allocation of residual losses affects trading and welfare in a central counterparty. I compare loss sharing under two loss-allocation mechanisms – variation margin haircutting and cash calls – and study the privately and socially optimal degree of loss sharing. For losses allocated using variation margin haircuts, I find that trading volume is sensitive to the degree of loss sharing and to the risk sensitivity of skin-in-the-game capital. By contrast, for cash calls, the degree of loss sharing does not affect trading volume but instead affects the chance that a cash call is honoured, which can constrain the recovery of funds. A welfare analysis characterizes the market outcome and compares it with the social optimum.

Suggested Citation

  • Radoslav Raykov, 2016. "To Share or Not to Share? Uncovered Losses in a Derivatives Clearinghouse," Staff Working Papers 16-4, Bank of Canada.
    • Handle: RePEc:bca:bocawp:16-4
    DOI: 10.34989/swp-2017-4
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    References listed on IDEAS

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    1. Philipp Haene & Andy Sturm, 2009. "Optimal Central Counterparty Risk Management," Working Papers 2009-07, Swiss National Bank.
    2. David Elliott, 2013. "Financial Stability Paper No 20: Central counterparty loss-allocation rules," Bank of England Financial Stability Papers 20, Bank of England.
    3. Koeppl, Thorsten V., 2013. "The Limits of Central Counterparty Clearing: Collusive Moral Hazard and Market Liquidity," Queen's Economics Department Working Papers 274637, Queen's University - Department of Economics.
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    Cited by:

    1. Lannoo, Karel, 2017. "Derivatives Clearing and Brexit: A comment on the proposed EMIR revisions," ECMI Papers 13150, Centre for European Policy Studies.

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    Keywords

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    JEL classification:

    • G19 - Financial Economics - - General Financial Markets - - - Other
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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