Assessing financial distress dependencies in OTC markets: a new approach using trade repositories data

Abstract

The recent financial crisis undoubtedly recognizes the importance of assessing not only the risk of distress for a single "financial entity", but also the distress dependencies between the different "entities", where by "entities" we mean in a broad sense any relevant cluster of products, risk factors, or counterparties. In this paper, we focus on the relationships among the sub-markets identified by the segmentation of the Interest Rate Swap (IRS) market according to contractual and financial features. We combine in an innovative way some new ingredients, namely the provision of more granular data on Over-the-Counter (OTC) derivatives by trade repositories along with the Joint Probability of Distress (JPoD) approach recently introduced by the International Monetary Fund (IMF) for studying the distress interdependence structure among financial institutions. In doing this, we define a distress indicator which combines some distress drivers, such as proxies for average traded volumes, liquidity spreads, and price dispersions. Results are quite close to the practical intuition: in many cases similarities between financial and contractual terms seem to be responsible for stronger co-dependences. However, high values for JPoD even in correspondence of quite dissimilar sub-markets suggests the presence of other drivers which need to be investigated in future research. To the best of our knowledge, this is the first empirical study based on micro-founded trade repositories' data on IRS for assessing systemic risk.