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Clearing, counterparty risk and aggregate risk

Author

Listed:
  • Biais, Bruno
  • Heider, Florian
  • Hoerova, Marie

Abstract

We study the optimal design of clearing systems. We analyze how counterparty risk should be allocated, whether traders should be fully insured against that risk, and how moral hazard affects the optimal allocation of risk. The main advantage of centralized clearing, as opposed to no or decentralized clearing, is the mutualization of risk. While mutualization fully insures idiosyncratic risk, it cannot provide insurance against aggregate risk. When the latter is significant, it is efficient that protection buyers exert effort to find robust counterparties, whose low default risk makes it possible for the clearing system to withstand aggregate shocks. When this effort is unobservable, incentive compatibility requires that protection buyers retain some exposure to counterparty risk even with centralized clearing. JEL Classification: G22, G28, D82

Suggested Citation

  • Biais, Bruno & Heider, Florian & Hoerova, Marie, 2012. "Clearing, counterparty risk and aggregate risk," Working Paper Series 1481, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20121481
    Note: 276127
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    References listed on IDEAS

    as
    1. Stephens, Eric & Thompson, James R., 2014. "CDS as insurance: Leaky lifeboats in stormy seas," Journal of Financial Intermediation, Elsevier, vol. 23(3), pages 279-299.
    2. David Mills & Francesca Carapella, 2012. "Information insensitive securities: the benefits of central counterparties," 2012 Meeting Papers 1032, Society for Economic Dynamics.
    3. Koeppl, Thorsten & Monnet, Cyril & Temzelides, Ted, 2012. "Optimal clearing arrangements for financial trades," Journal of Financial Economics, Elsevier, vol. 103(1), pages 189-203.
    4. Thorsten Koeppl & Cyril Monnet, 2006. "Central Counterparties," 2006 Meeting Papers 513, Society for Economic Dynamics.
    5. Acharya, Viral & Bisin, Alberto, 2014. "Counterparty risk externality: Centralized versus over-the-counter markets," Journal of Economic Theory, Elsevier, vol. 149(C), pages 153-182.
    6. James R. Thompson, 2010. "Counterparty Risk in Financial Contracts: Should the Insured Worry About the Insurer?," The Quarterly Journal of Economics, Oxford University Press, vol. 125(3), pages 1195-1252.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    aggregate and idiosyncratic risk; central clearing counterparty; counterparty risk; moral hazard; mutualization; optimal contracting; risk-sharing;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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