'An Agent-based Stress Testing Framework of Central Clearing (G4, G2)
AbstractWe put forward a partial equilibrium model of a central counterparty (CCP) and clearing members (CM). Agents are profit optimizing and are exposed to market risk. We simulate the balance sheets and the leverage of the CCP and the CMs as a result of the market price movements. We also model the margin shortfalls and the entire default waterfall in case of CM defaults. Moreover, we analyze the stability of the network of counterparties in a system with and without a CCP. We compare the stability of the networks with and without a CCP by analyzing i) endogenous feedback effects between CM defaults and market liquidity, ii) the contagion to non-defaulting CM as well as iii) the contagion from service functions that CMs provide to the CCPs, such as liquidity provision or collateral and investment services.
We find that in a system with a single CCP overall less defaults occur than in a system without a CCP. In addition, a CCP mitigates contagion measured by lower amount of 2nd-round defaults. We also find that mark-to-market price feedbacks have considerable adverse impact on the stability of the system, while that the mutualization of losses has a strong stabilizing effect.