Counterparty Risk Externality: Centralized Versus Over-the-counter Markets / Viral V. Acharya, Alberto Bisin.

Format:

Book

Author/Creator:

Acharya, Viral V.

Contributor:

National Bureau of Economic Research.

Bisin, Alberto.

Series:

Working Paper Series (National Bureau of Economic Research) no. w17000.

NBER working paper series no. w17000

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Counterparty Risk Externality

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2011.

Summary:

We model the opacity of over-the-counter (OTC) markets in a setup where agents share risks, but have incentives to default and their financial positions are not mutually observable. We show that this setup results in excess "leverage" in that parties take on short OTC positions that lead to levels of default risk that are higher than Pareto-efficient ones. In particular, OTC markets feature a "counterparty risk externality" that we show can lead to ex-ante productive inefficiency. This externality is absent when trading is organized via a centralized clearing mechanism that provides transparency of trade positions, or a centralized counterparty (such as an exchange) that observes all trades and sets prices competitively. While collateral requirements and subordination of OTC positions in bankruptcy can ameliorate the counterparty risk externality, they are in general inadequate in addressing it fully.

Notes:

Print version record

April 2011.