Finance Seminar: Martin Oehmke, London School of Economics and Political Science

Presenter: Martin Oehmke, London School of Economics and Political Science

Title: Margins as Canaries in the Coal Mine

Abstract: Central clearing counterparties (CCPs) manage counterparty risk by requiring clearing members to post margins. This paper explores the role of margins as “canaries in the coal mine:” By inducing defaults of fragile counterparties before contract maturity, margin calls enable CCPs to transfer these contracts to other counterparties, thereby preserving risk sharing. Our model reveals a pecking order of CCP risk management tools. When fragility is low, loss sharing among original counterparties suffices. When fragility is high, such that defaults at contract maturity would trigger cascading failures among clearing members, the CCP optimally complements loss sharing with margins. It is optimal to use margins as canaries when the balance sheets of fragile counterparties are severely impaired. Our findings highlight the complementary nature of CCP risk management tools: margins, loss sharing, and counterparty replacement.

Host: Stefan Hirth

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