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Central Counterparty Default Waterfalls and Systemic Loss

Published online by Cambridge University Press:  28 November 2022

Samim Ghamami ,
Mark Paddrik Open the ORCID record for Mark Paddrik [Opens in a new window]  and
Simpson Zhang
Samim Ghamami
Affiliation:
University of California Berkeley Center for Risk Management Research, New York University Courant Institute, and New York University Department of Finance and Risk Engineering samim_ghamami@berkeley.edu
Mark Paddrik*
Affiliation:
U.S. Department of the Treasury Office of Financial Research
Simpson Zhang
Affiliation:
Office of the Comptroller of the Currency Market Risk Analysis Division Simpson.Zhang@occ.treas.gov
*
Mark.Paddrik@ofr.treasury.gov (corresponding author)
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Abstract

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Central counterparty (CCP) default waterfalls act as the last lines of defense in over-the-counter markets by managing and allocating resources to cover payment defaults. This article examines the impact of variations in waterfall design on financial system losses in the presence of payment network dependencies and frictions in the cleared and noncleared portion of the system. Through the development of a structural model, we draw several theoretical conclusions about the effectiveness of CCP default waterfalls under severe payment stress. These findings are empirically quantified by testing the model using supervisory data for the U.S. credit default swap market.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 58 , Issue 8 , December 2023 , pp. 3577 - 3612
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank the anonymous referees, Celso Brunetti, Roy Cheruvelil, Ben Craig, Stéphane Crépey, Peter Curley, Selman Erol, Katherine Gleason, Stephen Kane, David Li, Sriram Rajan, Stacey Schreft, Stathis Tompaidis, Jessie Jiaxu Wang, Robert Wasserman, H. Peyton Young, John Zitko and participants of the 2019 Network Science and Economics Conference, 2019 Canadian Economic Association Annual Meeting, 2019 SIAM Conference on Financial Mathematics and Engineering: CCP Symposium, 2019 Western Finance Association Conference, 2019 Society for Economic Dynamics Meeting, 2019 FDIC/JFSR Bank Research Conference, and 2019 OFR/FRBC Financial Stability Conference for their valuable comments. We thank Elizabeth McKee for her excellent assistance in aggregating CCP filings and analyzing CCP manuals. Additionally, we thank OFR’s High Performance Computing, Data, and Legal teams for collecting and organizing the data necessary to make this project possible. The views expressed in this article do not necessarily reflect the views of the Office of the Comptroller of the Currency, the Office of Financial Research, the U.S. Department of the Treasury, or any federal agency and do not establish supervisory policy, requirements, or expectations.

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