Risk management of central counterparties

Purpose and goal

In this project, we develop tools for quantitative risk management of so-called central counterparties (sometimes also referred to as clearinghouses) with a focus on systemic risk and liquidity risk. Such tools will help both central counterparties and regulators to better understand systemic risk scenarios as those in 2007-2008, which led to the worst financial crises in modern times, forcing governments around the world to bail out many financial institutions, with huge costs for tax payers.

Expected effects and result

Financial models that study how much capital that should be held by a central counterparty are of great importance. Today, it is unclear how to determine the optimal amount of collateral that should be accumulated by central counterparties or what the optimal ratio between the different types of loss-absorbing capital should be. Furthermore, it is unclear how to design clearinghouses to minimize the risk of default contagion. Examples of research questions that will be studied in this project are finding the optimal levels of loss-absorbing capital to be held by a central counterparty.

Planned approach and implementation

We will develop financial models where the above issues related to quantitative risk management of central counterparties are addressed in different types of contexts. The models involve financial economics, probability theory, stochastic processes, statistics, optimization and various numerical methods. Data linked to default probabilities for different companies are retrieved from available databases. Our models will be developed in a series of research articles during the project period.