Failure and Rescue in Central Clearing Counterparty Design

29 Pages Posted: 25 Jul 2017 Last revised: 16 Oct 2017

See all articles by Zhenyu Cui

Zhenyu Cui

Stevens Institute of Technology - School of Business

Chihoon Lee

Stevens Institute of Technology

Yanchu Liu

Lingnan (University) College, Sun Yat-sen University, Guangzhou, China.

Kai Wang

Stevens Institute of Technology - School of Business

Date Written: October 15, 2017

Abstract

After the financial crisis, a financial innovation, the central clearing counterparty (CCP) has been proposed and proved its importance in facilitating the clearing of interbank liabilities. In its original design, there is a possibility that the CCP may go default, and thus jeopardizing the stability of the financial system. In order to address this issue, we propose a New Central Clearing Counterparty (NCCP) design. In our model, banks with positive cash balance are always able to stop the fire sales and help the troubled banks in the system. The rescue process leads to benefits for all banks in the long run and many banks also have incentives to do so even from the perspective of short term benefits. We measure the effects of default from both the default loss and the liquidation loss. The liquidation loss not only affects the banks who are going to do the fire sale, but also leads to a decrease on the net worth of solvent banks. An empirical study based on the Bankscope data set is carried out to illustrate the advantages of the new design in harnessing the systemic risk.

Keywords: systemic risk, network model, central clearing counterparty, financial innovation

JEL Classification: D85, C61, G21

Suggested Citation

Cui, Zhenyu and Lee, Chihoon and Liu, Yanchu and Wang, Kai, Failure and Rescue in Central Clearing Counterparty Design (October 15, 2017). Stevens Institute of Technology School of Business Research Paper, Available at SSRN: https://ssrn.com/abstract=3006579 or http://dx.doi.org/10.2139/ssrn.3006579

Zhenyu Cui (Contact Author)

Stevens Institute of Technology - School of Business ( email )

Hoboken, NJ 07030
United States

HOME PAGE: http://sites.google.com/site/zhenyucui86/publications

Chihoon Lee

Stevens Institute of Technology ( email )

Hoboken, NJ 07030
United States

Yanchu Liu

Lingnan (University) College, Sun Yat-sen University, Guangzhou, China. ( email )

Haizhu District,
Guangzhou, China.
Guangzhou, Guangdong 510275
China

Kai Wang

Stevens Institute of Technology - School of Business ( email )

Hoboken, NJ 07030
United States

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