A systemic change of measure from central clearing

Abstract

This study investigates the systemic impact of central clearing based on a financial network model in which edge weights represent the sensitivities of one participant's failure to its counterparties' default likelihood. The reduced-form model specifies the mechanism of systemic risk concentration under central clearing in that a central counterparty redistributes the probability mass of the systemic failure from the center of the distribution into its tail. Numerical illustrations shed light on implications for regulating the adverse dependence between risk concentration under central clearing and the resiliency of the financial system via proper margin schemes.