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Market structure, counterparty risk, and systemic risk

Author

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  • Rosenthal, Dale W.R.

Abstract

Networks 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.

Suggested Citation

  • Rosenthal, Dale W.R., 2009. "Market structure, counterparty risk, and systemic risk," MPRA Paper 36786, University Library of Munich, Germany, revised 19 Dec 2011.
  • Handle: RePEc:pra:mprapa:36786
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    File URL: https://mpra.ub.uni-muenchen.de/36939/1/MPRA_paper_36939.pdf
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    References listed on IDEAS

    as
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    Cited by:

    1. Alexander von Felbert, 2015. "Network Structure and Counterparty Credit Risk," Papers 1504.06789, arXiv.org, revised Jul 2015.

    More about this item

    Keywords

    network model; systemic risk; contagion; predatory trading;

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G01 - Financial Economics - - General - - - Financial Crises
    • D49 - Microeconomics - - Market Structure, Pricing, and Design - - - Other

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