Market liquidity, closeout procedures and initial margin for CCPs

Multiplex network analysis of the UK over‐the‐counter derivatives market

“…In Paddrik et al (2016), VMs are computed based on the impact the CCAR stress test has on credit ratings, which in turn influence the net present value of the open derivative positions. Given the greater complexity of our network, which includes different classes of contracts, here we take a simpler approach whereby shocks are estimated by means of an impact valuation model (Heath et al, 2016;Cerezetti et al, 2017;Bardoscia et al, 2015;2017). This allows us to disregard the complexity of repricing all derivative contracts and, at the same time, it permits us to study the response of the system to a wide class of shocks.…”

Financial markets, innovation and regulation

“…The added friction stemming from managing a default can be often overlooked when designing hedging strategies along with the associated transaction costs. Cerezetti et al (2019) use an unexplored transactional-level data-set on interest rate swaps and assume hypothetical defaults of actual CCP clearing members. The authors' main argument is that both pre-funded requirements for collateralising exposure and close-out procedures following a clearing member's default are complementary and should be jointly treated for the risk management process.…”

“…via the contagion originating from defaulting and closeout procedures) increasing market volatility. Cerezetti et al (2019) derive an efficient hedging strategy that accounts for the market funding liquidity risk of CCPs and for transaction costs, therefore, avoiding unnecessary model risk and offers a timely support towards regulatory requirements on CCPs. When accounting for transaction costs the optimal hedging strategy for CCPs is one with a limited number of instruments, suggesting a macro hedging strategy would be the most efficient option.…”