Model risk at central counterparties: is skin in the game a game changer?

Huang, Wenqian and Takáts, Előd (2024) Model risk at central counterparties: is skin in the game a game changer? International Journal of Central Banking, 20 (3). 161 - 184. ISSN 1815-4654

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Abstract

As central counterparties (CCPs) have become systemic, their credit risk modeling has become critical for the global financial system. This paper empirically investigates CCPs’ incentives to model credit risk. Our hypothesis is that the more CCPs stand to lose from mismanagement, the more conservatively they model credit risk. Accordingly, we find that the higher the skin in the game, i.e., the CCP capital dedicated to credit risk, the lower the model risk is. The results are significant and robust across different model risk proxies. Consistent with our hypothesis, the association with other forms of capital is not significant. Our findings inform the policy debate on CCP capital regulation.

Item Type:	Article
Official URL:	https://www.ijcb.org/
Additional Information:	© 2024 International Journal of Central Banking
Divisions:	LSE
Subjects:	H Social Sciences > HG Finance
JEL classification:	F - International Economics > F3 - International Finance > F34 - International Lending and Debt Problems F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F42 - International Policy Coordination and Transmission G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages G - Financial Economics > G3 - Corporate Finance and Governance > G38 - Government Policy and Regulation
Date Deposited:	26 Jul 2024 08:00
Last Modified:	14 Sep 2024 10:12
URI:	http://eprints.lse.ac.uk/id/eprint/124360

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