Do central counterparties reduce counterparty and liquidity risk? Empirical results

2021 ◽  
pp. 1-10
Author(s):  
Carlos León ◽  
Ricardo Mariño ◽  
Carlos Cadena
Keyword(s):  
Financial Markets ◽  
Financial Institutions ◽  
Liquidity Risk ◽  
Counterparty Risk ◽  
Financial Contracts ◽  
Empirical Results ◽  
Forward Market ◽  
Central Counterparties ◽  
Clearing And Settlement ◽  
First Time

A central counterparty (CCP) interposes itself between buyers and sellers of financial contracts to extinguish their bilateral exposures. Therefore, central clearing and settlement through a CCP should affect how financial institutions engage in financial markets. Though, financial institutions’ interactions are difficult to observe and analyze. Based on a unique transactional dataset corresponding to the Colombian peso non-delivery forward market, this article compares—for the first time—networks of transactions agreed to be cleared and settled by the CCP with those to be cleared and settled bilaterally. Networks to be centrally cleared and settled show significantly higher connectivity and lower distances among financial institutions. This suggests that agreeing on central clearing and settlement reduces liquidity risk. After CCP interposition, exposure networks show significantly lower connectivity and higher distances, consistent with a reduction of counterparty risk. Consequently, evidence shows CCPs induce a change of behavior in financial institutions that emerges as two distinctive economic structures for the same market, which corresponds to CCP’s intended reduction of liquidity and counterparty risks.

scholarly journals An Economic Examination of Collateralization in Different Financial Markets

2019 ◽  
Author(s):  
Tim Xiao
Keyword(s):  
Risk Factors ◽  
Credit Risk ◽  
Financial Markets ◽  
Counterparty Risk ◽  
Financial Contracts ◽  
Theoretical Justification ◽  
Data Set ◽  
Unique Data ◽  
Economic Significance ◽  
The Difference

This paper attempts to assess the economic significance and implications of collateralization in different financial markets, which is essentially a matter of theoretical justification and empirical verification. We present a comprehensive theoretical framework that allows for collateralization adhering to bankruptcy laws. As such, the model can back out differences in asset prices due to collateralized counterparty risk. This framework is very useful for pricing outstanding defaultable financial contracts. By using a unique data set, we are able to achieve a clean decomposition of prices into their credit risk factors. We find empirical evidence that counterparty risk is not overly important in credit-related spreads. Only the joint effects of collateralization and credit risk can sufficiently explain unsecured credit costs. This finding suggests that failure to properly account for collateralization may result in significant mispricing of financial contracts. We also analyze the difference between cleared and OTC markets.

scholarly journals From illiquid financial instrument to market distress – selected institutional circumstances of the credit crisis

Equilibrium ◽  
2009 ◽  
Vol 2 (1) ◽  
pp. 29-38 ◽  
Author(s):  
Anna Krześniak
Keyword(s):  
Financial Markets ◽  
Financial Stability ◽  
Critical Role ◽  
Financial System ◽  
Liquidity Risk ◽  
Price Volatility ◽  
Counterparty Risk ◽  
Credit Crisis ◽  
Financial Instrument ◽  
Underlying Mechanisms

The recently observed credit crunch is yet another market disruption confirming the critical role of liquidity in the financial system. It is however the first time that illiquidity of a single financial instrument has led to illiquidity of a significant part of the financial system. Although the credit crisis had limited effect on the Polish economy, thorough understanding of the underlying mechanisms is necessary to properly monitor the financial stability in the future, as the Polish financial system gets more integrated into the global one. The article discusses selected mechanisms of the crisis and concentrates on the characteristics of the financial markets that led to the sudden spill-over of the turbulence in the global financial markets. The paper highlights the two types of risk, which were underestimated in the past, but played a major role in instigating and magnifying the recent crisis. The first one is the liquidity risk, which may undermine the reliability of the mark-to-market valuation and produce extreme price volatility once the confidence in such valuations is eroded. The second one is the counterparty risk which results from concentration of market turnover in the period of rapidly growing volumes of derivatives traded in the market. The article leads to the conclusion that the lack of transparency and liquidity on the credit risk markets triggered the severe financial crisis in the global financial market. The analysis of the liquidity risk and the counterparty risk illustrates that some institutions became crucial for the functioning not only domestic but also global markets.

scholarly journals Measurement of Systemic Risk in Global Financial Markets and Its Application in Forecasting Trading Decisions

2020 ◽  
Vol 12 (10) ◽  
pp. 4000 ◽  
Author(s):  
Jianxu Liu ◽  
Quanrui Song ◽  
Yang Qi ◽  
Sanzidur Rahman ◽  
Songsak Sriboonchitta
Keyword(s):  
Financial Markets ◽  
Financial Institutions ◽  
Systemic Risk ◽  
Decision Model ◽  
Global Financial Crisis ◽  
Joint Models ◽  
Policy Makers ◽  
Trading Decisions ◽  
The Global Financial Crisis ◽  
First Time

The global financial crisis in 2008 spurred the need to study systemic risk in financial markets, which is of interest to both academics and practitioners alike. We first aimed to measure and forecast systemic risk in global financial markets and then to construct a trade decision model for investors and financial institutions to assist them in forecasting risk and potential returns based on the results of the analysis of systemic risk. The factor copula-generalized autoregressive conditional heteroskedasticity (GARCH) models and component expected shortfall (CES) were combined for the first time in this study to measure systemic risk and the contribution of individual countries to global systemic risk in global financial markets. The use of factor copula-based models enabled the estimation of joint models in stages, thereby considerably reducing computational burden. A high-dimensional dataset of daily stock market indices of 43 countries covering the period 2003 to 2019 was used to represent global financial markets. The CES portfolios developed in this study, based on the forecasting results of systemic risk, not only allow spreading of systemic risk but may also enable investors and financial institutions to make profits. The main policy implication of our study is that forecasting systemic risk of global financial markets and developing portfolios can provide valuable insights for financial institutions and policy makers to diversify portfolios and spread risk for future investments and trade.

scholarly journals Pricing Financial Derivatives Subject to Multilateral Credit Risk and Collateralization

2019 ◽  
Author(s):  
Tim Xiao
Keyword(s):  
Asset Pricing ◽  
Credit Risk ◽  
Financial Markets ◽  
Default Risk ◽  
Credit Default Swap ◽  
Financial Derivatives ◽  
Counterparty Risk ◽  
Financial Contracts ◽  
Credit Default ◽  
Default Swap

This article presents a new model for valuing financial contracts subject to credit risk and collateralization. Examples include the valuation of a credit default swap (CDS) contract that is affected by the trilateral credit risk of the buyer, seller and reference entity. We show that default dependency has a significant impact on asset pricing. In fact, correlated default risk is one of the most pervasive threats in financial markets. We also show that a fully collateralized CDS is not equivalent to a risk-free one. In other words, full collateralization cannot eliminate counterparty risk completely in the CDS market.

scholarly journals An Economic Examination of Collateralization in Different Financial Markets

2019 ◽  
Author(s):  
Tim Xiao
Keyword(s):  
Risk Factors ◽  
Credit Risk ◽  
Financial Markets ◽  
Counterparty Risk ◽  
Financial Contracts ◽  
Theoretical Justification ◽  
Data Set ◽  
Unique Data ◽  
Economic Significance ◽  
The Difference

This paper attempts to assess the economic significance and implications of collateralization in different financial markets, which is essentially a matter of theoretical justification and empirical verification. We present a comprehensive theoretical framework that allows for collateralization adhering to bankruptcy laws. As such, the model can back out differences in asset prices due to collateralized counterparty risk. This framework is very useful for pricing outstanding defaultable financial contracts. By using a unique data set, we are able to achieve a clean decomposition of prices into their credit risk factors. We find empirical evidence that counterparty risk is not overly important in credit-related spreads. Only the joint effects of collateralization and credit risk can sufficiently explain unsecured credit costs. This finding suggests that failure to properly account for collateralization may result in significant mispricing of financial contracts. We also analyze the difference between cleared and OTC markets.

Analysis of Influence Factors of Non-Performing Loans and Path Based on the Dynamic Control Theory

2017 ◽  
Vol 21 (6) ◽  
pp. 1087-1093
Author(s):  
Zhenlei Wang ◽  
Song Qin ◽  
◽  
◽  
Keyword(s):  
Control Theory ◽  
Financial Markets ◽  
Financial Institutions ◽  
Dynamic Control ◽  
Influence Factors ◽  
Theory Model ◽  
Hamilton Function ◽  
Factors Affecting ◽  
Set Up ◽  
First Time

The balance of non-performing loans (NPLs) of Chinese banking financial institutions rebounded for the first time after 2005, and credit risk has emerged as one of the rapidly rising risks in today’s financial markets. In this study, we focus on the NPLs of financial institutions. In particular, the factors affecting their rate are studied. A dynamic control theory model is used to set up a Hamilton function for describing the effect of these factors. Moreover, the path of NPLs under the influence of various factors is obtained. It was found that improved risk control and macroeconomy factors reduced the number of NPLs. In particular, to reduce the number of NPLs, the capacity of banks to manage loans should be strengthened.

scholarly journals An Economic Examination of Collateralization in Different Financial Markets

2019 ◽  
Author(s):  
Tim Xiao
Keyword(s):  
Risk Factors ◽  
Credit Risk ◽  
Financial Markets ◽  
Counterparty Risk ◽  
Financial Contracts ◽  
Theoretical Justification ◽  
Data Set ◽  
Unique Data ◽  
Economic Significance ◽  
The Difference

This paper attempts to assess the economic significance and implications of collateralization in different financial markets, which is essentially a matter of theoretical justification and empirical verification. We present a comprehensive theoretical framework that allows for collateralization adhering to bankruptcy laws. As such, the model can back out differences in asset prices due to collateralized counterparty risk. This framework is very useful for pricing outstanding defaultable financial contracts. By using a unique data set, we are able to achieve a clean decomposition of prices into their credit risk factors. We find empirical evidence that counterparty risk is not overly important in credit-related spreads. Only the joint effects of collateralization and credit risk can sufficiently explain unsecured credit costs. This finding suggests that failure to properly account for collateralization may result in significant mispricing of financial contracts. We also analyze the difference between cleared and OTC markets.

scholarly journals An Economic Examination of Collateralization in Different Financial Markets

2019 ◽  
Author(s):  
Tim Xiao
Keyword(s):  
Risk Factors ◽  
Credit Risk ◽  
Financial Markets ◽  
Counterparty Risk ◽  
Financial Contracts ◽  
Theoretical Justification ◽  
Data Set ◽  
Unique Data ◽  
Economic Significance ◽  
The Difference

This paper attempts to assess the economic significance and implications of collateralization in different financial markets, which is essentially a matter of theoretical justification and empirical verification. We present a comprehensive theoretical framework that allows for collateralization adhering to bankruptcy laws. As such, the model can back out differences in asset prices due to collateralized counterparty risk. This framework is very useful for pricing outstanding defaultable financial contracts. By using a unique data set, we are able to achieve a clean decomposition of prices into their credit risk factors. We find empirical evidence that counterparty risk is not overly important in credit-related spreads. Only the joint effects of collateralization and credit risk can sufficiently explain unsecured credit costs. This finding suggests that failure to properly account for collateralization may result in significant mispricing of financial contracts. We also analyze the difference between cleared and OTC markets.

scholarly journals Pricing Financial Derivatives Subject to Multilateral Credit Risk and Collateralization

2019 ◽  
Author(s):  
Tim Xiao
Keyword(s):  
Asset Pricing ◽  
Credit Risk ◽  
Financial Markets ◽  
Default Risk ◽  
Credit Default Swap ◽  
Financial Derivatives ◽  
Counterparty Risk ◽  
Financial Contracts ◽  
Credit Default ◽  
Default Swap

This article presents a new model for valuing financial contracts subject to credit risk and collateralization. Examples include the valuation of a credit default swap (CDS) contract that is affected by the trilateral credit risk of the buyer, seller and reference entity. We show that default dependency has a significant impact on asset pricing. In fact, correlated default risk is one of the most pervasive threats in financial markets. We also show that a fully collateralized CDS is not equivalent to a risk-free one. In other words, full collateralization cannot eliminate counterparty risk completely in the CDS market.

scholarly journals Pricing Financial Derivatives Subject to Multilateral Credit Risk and Collateralization

2019 ◽  
Author(s):  
Tim Xiao
Keyword(s):  
Asset Pricing ◽  
Credit Risk ◽  
Financial Markets ◽  
Default Risk ◽  
Credit Default Swap ◽  
Financial Derivatives ◽  
Counterparty Risk ◽  
Financial Contracts ◽  
Credit Default ◽  
Default Swap

This article presents a new model for valuing financial contracts subject to credit risk and collateralization. Examples include the valuation of a credit default swap (CDS) contract that is affected by the trilateral credit risk of the buyer, seller and reference entity. We show that default dependency has a significant impact on asset pricing. In fact, correlated default risk is one of the most pervasive threats in financial markets. We also show that a fully collateralized CDS is not equivalent to a risk-free one. In other words, full collateralization cannot eliminate counterparty risk completely in the CDS market.

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