Monday, October 11, 2010

Emergence and Future of Central Counterparties

By Thorsten V. Koeppl and Cyril Monnet

Abstract: The authors explain why central counterparties (CCPs) emerged historically. With standardized contracts, it is optimal to insure counterparty risk by clearing those contracts through a CCP that uses novation and mutualization. As netting is not essential for these services, it does not explain why CCPs exist. In over-the-counter markets, as contracts are customized and not fungible, a CCP cannot fully guarantee contract performance. Still, a CCP can help: As bargaining leads to an inefficient allocation of default risk relative to the gains from customization, a transfer scheme is needed. A CCP can implement it by offering partial insurance for customized contracts.

Download here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1687862

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