Does a Central Clearing Counterparty Reduce Counterparty Risk?
Darrell Duffie, Stanford University
Haoxiang Zhu, Stanford University
We show whether adding a central clearing counterparty (CCP) for a particular asset class, such as credit derivatives, improves the efficiency of counterparty risk mitigation and collateral demands, relative to bilateral netting between pairs of dealers. We show that, for plausible cases, adding a CCP for one class of derivatives such as credit default swaps (CDS) can actually reduce netting efficiency and thereby lead to an increase in collateral demands and average exposure to counterparty default. We also show that whenever it is efficient to introduce a central clearing counterparty, it cannot be efficient to introduce more than one CCP for the same class of derivatives.