Clearinghouse Default Waterfalls: Risk-Sharing, Incentives, and Systemic Risk

Capponi, Agostino; Cheng, W. Allen; Sethuraman, Jay

doi:10.2139/ssrn.2930099

Cited by 6 publications

(7 citation statements)

References 17 publications

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“…In the context of central counterparty clearinghouses, the default fund contributions, margin requirements and participation incentives have been studied in, e.g., [5], [1], and [8]. The critical question in this area is understanding the effects of a liquidation policy of a member's portfolio in the case of a significant event.…”

Section: Relation To Prior Workmentioning

confidence: 99%

“…In our model, the single speculative agent, which is not a price-taker, is intended to reflect the aggregate behavior of many individual speculators, each with small market power. 5 In a normal liquid market, an individual speculator would be able to repurchase DStablecoins at dollar cost and walk away with the equity. By maximizing equity, the aggregate speculator considers its liabilities to be $1 per DStablecoin.…”

Section: Aggregate Vs Individual Speculatorsmentioning

confidence: 99%

See 1 more Smart Citation

(In)Stability for the Blockchain: Deleveraging Spirals and Stablecoin Attacks

Klages‐Mundt¹,

Minca²

2019

Preprint

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We develop a model of stable assets, including noncustodial stablecoins backed by cryptocurrencies. Such stablecoins are popular methods for bootstrapping price stability within public blockchain settings. We demonstrate fundamental results about dynamics and liquidity in stablecoin markets, demonstrate that these markets face deleveraging spirals that cause illiquidity during crises, and show that these stablecoins have 'stable' and 'unstable' domains. Starting from documented market behaviors, we explain actual stablecoin movements; further our results are robust to a wide range of potential behaviors. In simulations, we show that these systems are susceptible to high tail volatility and failure. Our model builds foundations for stablecoin design. Based on our results, we suggest design improvements that can improve long-term stability and suggest methods for solving pricing problems that arise in existing stablecoins. In addition to the direct risk of instability, our dynamics results suggest a profitable economic attack during extreme events that can induce volatility in the 'stable' asset. This attack additionally suggests ways in which stablecoins can cause perverse incentives for miners, posing risks to blockchain consensus.

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Section: Relation To Prior Workmentioning

confidence: 99%

Section: Aggregate Vs Individual Speculatorsmentioning

confidence: 99%

(In)Stability for the Blockchain: Deleveraging Spirals and Stablecoin Attacks

Klages‐Mundt¹,

Minca²

2019

Preprint

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“…Previous studies have examined loss sharing and its interaction with CCP collateral and fee policies (Capponi, Cheng, and Sethuraman (2017), Capponi and Cheng (2018), Huang (2018)) as well as its impact on clearing members' propensity to engage in risk-shifting (Biais, Heider, and Hoerova (2016), Capponi et al (2019)). In a simulation study, Lewandowska (2015) shows that loss sharing may reduce loss concentration and counterparty risk exposure compared to bilateral netting in the absence of systematic risk, extreme events, or heterogeneous portfolio directionality.…”

Section: Literature Reviewmentioning

confidence: 99%

The Pitfalls of Central Clearing in the Presence of Systematic Risk

2018

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Through the lens of market participants' objective to minimize counterparty risk, we investigate central clearing in derivatives markets, and its interaction with systematic risk, portfolio directionality, and loss sharing. Previous studies suggest that central clearing always reduces counterparty risk for a sufficiently large number of clearing members. We show that this is not the case-mostly because of loss sharing. Central clearing can increase counterparty risk, particularly during extreme market events, for traders with directional portfolios, and because CCPs mutualize default losses. Our results are consistent with the reluctance to clear derivative trades in the absence of a clearing obligation.

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“…In the case of more minor market shocks, requiring more waterfall resources will not counterbalance the consequences of decreased central clearing participation. This result highlights the downward pressure on waterfall resources that a CCP faces in periods of market calm, which is in line with the downward trends in CCP waterfall resources in the decade following the 2008 financial crisis.Previous papers that examined CCP default waterfall designs includeCapponi et al (2017), which examines the CCP's role in attracting less risky membership and the consequences for risk sharing from allocating risk to themselves in the default waterfall. In contrast, we consider the aggregate loss to firms and counterparty externalities, similar toAcharya and Bisin (2014),Ghamami (2015) andGhamami and Glasserman (2017), by incorporating the impacts of several layers of the waterfall on client clearing and non-cleared positions into our analysis.…”

mentioning

confidence: 99%

Central Counterparty Default Waterfalls and Systemic Loss

Ghamami¹,

Paddrik²,

Zhang³

2022

J. Financ. Quant. Anal.

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The Office of Financial Research (OFR) Working Paper Series allows members of the OFR staff and their coauthors to disseminate preliminary research findings in a format intended to generate discussion and critical comments. Papers in the OFR Working Paper Series are works in progress and subject to revision.Views and opinions expressed are those of the authors and do not necessarily represent official positions or policy of the OFR or Treasury. Comments and suggestions for improvements are welcome and should be directed to the authors. OFR working papers may be quoted without additional permission.

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Clearinghouse Default Waterfalls: Risk-Sharing, Incentives, and Systemic Risk

Cited by 6 publications

References 17 publications

(In)Stability for the Blockchain: Deleveraging Spirals and Stablecoin Attacks

(In)Stability for the Blockchain: Deleveraging Spirals and Stablecoin Attacks

The Pitfalls of Central Clearing in the Presence of Systematic Risk

Central Counterparty Default Waterfalls and Systemic Loss

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