Central Counterparty Risk

Matthias Arnsdorf


Central counterparties (CCPs) are a key part of the financial system. They have increased in significance since the 2007–9 financial crisis and are viewed as a key mitigant of credit risk and contagion while also providing increased transparency to the derivatives market.

As discussed in Chapter 2, CCPs are designed to reduce counterparty risk by holding high levels of collateral and by mutualising losses among clearing members. However, in extreme, stressed markets, the CCP funds may be insufficient to cover the portfolio losses of a defaulting clearing member. In these cases clearing members are exposed to concentrated tail risk and can incur losses on their default fund contributions and trade exposures. This does not necessarily require the default of the CCP itself.

This chapter is an extension of the framework introduced in Arnsdorf (2012, 2014), where we explore methodologies for quantifying the risk that a bank has when facing a CCP. Here we shall summarise the calculation of stress and expected exposures and look at how these measures can be applied in practice. In particular, we consider applications to stress tests such as the regulatory

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