Optimal Central Counterparty Risk Management

June 1, 2009
Issue 2009-07

Summary

In order to protect themselves against the potential losses in case of a participant's default and to contain systemic risk, central counterparties (CCPs) need to maintain sufficient financial resources. Typically, these financial resources consist of margin requirements and contributions to a collective default fund. Based on a stylized model of CCP risk management, this article analyzes the main factors affecting the trade-off between margins and default fund. The optimal balance between these two risk management instruments is found to depend on collateral costs, participants' default probability, and the extent to which margin requirements are associated with risk-mitigating incentives. Given the increasing role of CCPs in financial markets in general and for financial stability in particular, these considerations are not only important for CCPs themselves, but also for financial regulators.

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Issue:
07
Pages:
28
JEL classification:
G23, G32, G18
Keywords:
Central counterparty, margin requirements, default fund, financial stability, incentives
Year:
2009

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Author(s)

  • Philipp Haene

  • Andy Sturm

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