Collateral, Netting and Systemic Risk in the OTC Derivatives Market

Singh, Manmohan

doi:10.5089/9781451982763.001

Cited by 69 publications

(33 citation statements)

References 4 publications

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“…Duffie et al (2014) improve on their estimates by using bilateral exposure data and by investigating a variety of clearing schemes. Hull (2010) discusses the possibility for all derivatives to be cleared, Sidanius (2012) the criterions for CCP eligibility, whereas Bliss and Steigerwald (2006) compare CCPs to alternative structures and Singh (2010aSingh ( , 2013 describes the changing collateral space.…”

Section: Relevant Literaturementioning

confidence: 99%

Endogenous Derivative Networks

Vuillemey

Breton

2014

SSRN Journal

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1 RésuméCet article développe un modèle de formation de réseau d'expositions dérivées, où prix et quantités sont négociés de gré-à-gré (OTC). La modélisation génère comme variables endogènes le réseau d'expositions, les montants bruts et nets échangés, ainsi que le collatéral délivré via les marges initiales et les marges de variation, en fonction du niveau de risque de contrepartie idiosyncratique et du cadre réglementaire en matière de collatéral et de compensation. Le modèle est utilisé pour analyser numériquement la taille du marché des dérivés, la demande totale de collatéral et les prix. Trois types de configuration sont analysés : (i) différents niveaux de collatéral-isation des transactions non compensées, (ii) la réhypothécation du collatéral reçu et (iii) la compensation via une contrepartie centrale. Les effets dynamiques dus à l'endogénéité du réseau d'expositions dérivées ont des conséquences significatives tant sur les volumes que sur les prix des contrats échangés. Les activités d'intermédiation et la liquidité du marché sont réduites par l'application de contraintes plus sévères en matière de collatéral, et améliorées par la réhypothécation. Parallèlement, le potentiel de contagion est réduit. Ne pas prendre en compte ces effets dynamiques peut conduire (dans les conditions de marché actuelles) à surestimer la demande de collatéral induite par la compensation centrale jusqu'à 22%.Mots-clés: collatéral, dérivés de crédit, contrepartie centrale (CCP), réseau endogène Code JEL: G11, G17, G28 AbstractThis paper proposes a network formation model of an OTC derivatives market where both prices and quantities are bilaterally negociated. The key feature of the framework is to endogenize the network of exposures, the gross and net notional amounts traded and the collateral delivered through initial and variation margins, as a function of idiosyncratic counterparty risk and regulatory collateral and clearing requirements. Using the framework, we investigate numerically the size of the derivatives network, the aggregate collateral demand and the pricing of the contracts under the following schemes: (i) various levels of collateralization for uncleared transactions, (ii) rehypothecation of received collateral and (iii) clearing through a central clearing party (CCP). Overall results suggest that dynamic effects due to the endogeneity of the derivative network to the collateralization and clearing requirements have sizeable consequences on both contract volumes and prices. Intermediary trading and market liquidity are reduced by higher collateralization requirements and enhanced by rehypothecation, while the potential for contagion is reduced. Not accounting for dynamic effects in current market conditions may lead to over-estimate collateral demand induced by mandatory central clearing by up to 22%.Keywords: Collateral, Credit derivatives, Central Clearing Party (CCP), Network formation JEL: G11, G17, G28 2 Non technical summaryOver-the-counter (OTC) derivatives markets will undergo significant changes as ma...

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Section: Relevant Literaturementioning

confidence: 99%

Endogenous Derivative Networks

Vuillemey

Breton

2014

SSRN Journal

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“…If a contract is over-collateralized (e.g., a repo or cleared contract), its value is equal to the 1 Singh (2010) and ECB (2009) come to a similar conclusion, although they do not provide any data to justify their statements. risk-free value.…”

Section: Introductionmentioning

confidence: 99%

An Economic Examination of Collateralization in Different Financial Markets

Xiao

2013

SSRN Journal

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“…23 See also Pirrong (2009), Singh (2010a, Hull (2010) and Jones and Pérignon (2013) for a discussion on the clearing of derivative markets using CCPs.…”

Section: Cds Marketmentioning

confidence: 99%

Credit Default Swaps: A Survey

et al. 2014

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Credit default swaps (CDS) have been growing in importance in the global financial markets. However, their role has been hotly debated, in industry and academia, particularly after the credit crisis of 2008-2009 and the European sovereign crisis of 2010-2012. We review the extant literature on CDS that has accumulated over the past two decades. We divide our survey into seven topics after providing a broad overview in the introduction. The second section traces the historical development of CDS markets and provides an introduction to CDS contract definitions and conventions. The third section discusses the pricing of CDS, from the perspective of no-arbitrage principles as well as from that of structural and reduced-form credit risk models. It also summarizes the literature on the determinants of CDS spreads, with a focus on the role of fundamental credit risk factors, liquidity and counterparty risk. The fourth section discusses how the development of the CDS market has affected the characteristics of the related bond and equity markets, with an emphasis on the closely related concepts of market efficiency, price discovery, information flow and liquidity. Attention is also paid to the CDS-bond basis, the wedge between the pricing of the CDS and its reference bond, and the mispricing between the CDS and the equity market, which leads to a discussion on capital structure arbitrage. The fifth section examines the effect of CDS trading on firms' credit and bankruptcy risk, and how it affects corporate financial policy, including bond issuance, capital structure, liquidity management, and both external and internal corporate governance. The sixth section summarizes the literature that takes into account how CDS may impact the incentives of the various agents in the economy and the associated impact on the pricing of the contracts. In particular, we examine how CDS may alter the debtor-creditor relationship. Section seven reviews the growing literature on sovereign CDS and highlights the major conceptual and contractual differences between the sovereign and corporate CDS markets. In section eight, we discuss CDS indices, especially the role of synthetic CDS index products backed by residential mortgage-backed securities during the financial crisis. We close with our suggestions for promising future research directions on CDS contracts and markets.

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Collateral, Netting and Systemic Risk in the OTC Derivatives Market

Cited by 69 publications

References 4 publications

Endogenous Derivative Networks

Endogenous Derivative Networks

An Economic Examination of Collateralization in Different Financial Markets

Credit Default Swaps: A Survey

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