Does a Central Clearing Counterparty Reduce …

Doesa Central Clearing CounterpartyReduce Counterparty Risk?Darrell Duffie and Haoxiang ZhuGraduate School of Business, Stanford UniversityWe show whether Central Clearing of a particular class of derivatives lowers counterpartyrisk. For plausible cases, adding a Central Clearing Counterparty (CCP) for a class of deriva-tives such as credit default swaps reduces netting efficiency, leading to an increase in av-erage exposure to Counterparty default. Further, Clearing different classes of derivatives inseparate CCPs always increases Counterparty exposures relative to Clearing the combinedset of derivatives in a single CCP. We provide theory as well as illustrative numerical ex-amples of these results that are calibrated to notional derivatives position data for majorbanks. (JELG01, G14, G18, G28) key element of the new regulatory approach to financial stability is the cen-tral Clearing of derivatives. A Central Clearing Counterparty (CCP) stands be-tween over-the-counter (OTC) derivatives counterparties, insulating them fromeach other s default.

Does a Central Clearing Counterparty Reduce Counterparty Risk? Darrell Duffie and Haoxiang Zhu Graduate School of Business, Stanford University We show whether central clearing of a particular class of derivatives lowers counterparty

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