Journal of Financial Market Infrastructures

Risk.net

Managing market liquidity risk in central counterparties

Evangelos Benos, Pedro Gurrola-Perez and Michael Wood

  • CCPs calculate liquidity add-ons by either attempting to directly estimate the cost of liquidating a position or by assuming a sufficiently extended margin period of risk (MPOR) during which liquidation costs are assumed to be minimal.
  • We show that the above two approaches are not always equivalent.
  • CCPs generally face data constraints in calibrating their concentration add-ons.
  • The CCP default waterfall should account for cases of extreme but plausible market illiquidity.

In the event of a clearing member’s default, and as part of its default management process, a central counterparty (CCP) will need to hedge the defaulter’s portfolio and close out its positions. However, the CCP may not be able to do this without incurring additional losses if the market is illiquid or the portfolio contains large, concentrated positions. To mitigate this liquidity risk, CCPs often require members to post additional collateral to the initial margin in the form of concentration add-ons. In the absence of a quantitative regulatory standard for calculating concentration add-ons, this paper discusses the different approaches to incorporating market liquidity risk within a CCP’s default waterfall and the challenges that these approaches pose.

To continue reading...

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an indvidual account here: