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Contagion in derivatives markets

Paddrick, Mark, Rajan, Sriram and Young, H. Peyton (2019) Contagion in derivatives markets. Management Science. ISSN 0025-1909 (In Press)

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Abstract

A major credit shock can induce large intra-day variation margin payments between counterparties in derivatives markets, which may force some participants to default on their payments. These payment shortfalls become amplied as they cascade through the network of exposures. Using detailed DTCC data we model the full network of exposures, shock-induced payments, initial margin collected, and liquidity buers for about 900 rms operating in the U.S. credit default swaps market. We estimate the total amount of contagion, the marginal contribution of each rm to contagion, and the number of defaulting rms for a systemic shock to credit spreads. A novel feature of the model is that it allows for a range of behavioral responses to balance sheet stress, including delayed or partial payments. The model provides a framework for analyzing the relative eectiveness of dierent policy options, such as increasing margin requirements or mandating greater liquidity reserves.

Item Type: Article
Additional Information: © 2019 INFORMS
Divisions: Mathematics
Subjects: H Social Sciences > HG Finance
Date Deposited: 23 May 2019 11:30
Last Modified: 16 Jun 2019 23:08
URI: http://eprints.lse.ac.uk/id/eprint/100868

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