A Dynamic Model of CCP Risk

We introduce a dynamic model of default waterfall of derivatives CCPs and propose a risk sensitive method for sizing the initial margin (IM), and the default fund (DF) and its allocation among clearing members. Using a... [ view full abstract ]

We introduce a dynamic model of default waterfall of derivatives CCPs and propose a risk sensitive method for sizing the initial margin (IM), and the default fund (DF) and its allocation among clearing members. Using a Markovian model of joint credit migrations, our evaluation of DF takes into account the joint credit quality of clearing members as they evolve over time. Another important aspect of the proposed methodology is the use of the time consistent dynamic risk measures for computation of IM and DF. We analyze the advantages of the proposed methodology and its comparison with the currently prevailing methods.