Counterparty Credit Risk Efficieny of Central Clearing

Abstract

In this thesis, we aim to show effects of centrally clearing OTC derivatives on counterparty exposures. Central clearing is the process of replacing bilateral exposures from transactions with a network of multilateral exposures. In all transactions, a central counterparty (CCP) is the intermediary, acting as a buyer to each seller and vice versa. Central clearing has been mandated by regulators to mitigate counterparty credit risk which was a major factor in the 2008/09 financial crisis. We emphasize credit default swaps which are a financial instrument that compensates in the case of a credit event and follow the model by Duffie and Zhu (2011) as well as part of the model extension by Cont and Kokholm (2014). Their research is related to clearing effciency when clearing a single derivative class. We show how netting efficiency is measured and that splitting counterparty clearing over several clearing facilities can have adverse effects to the intended purpose of the clearing system in some settings. We show that there is a tradeoff between bilateral netting between counterparties across asset classes and multilateral netting between several counterparties for single asset classes, e.g. credit derivatives.