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Discussion Paper Details

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Title: Stress Testing Networks: The Case of Central Counterparties

Author(s): Richard Berner, Stephen G Cecchetti and Kermit Schoenholtz

Publication Date: March 2019

Keyword(s): CCP, central counterparties, financial network, financial regulation, Financial Stability, Resolution, SRISK and Stress Testing

Programme Area(s): Financial Economics and International Macroeconomics and Finance

Abstract: Stress tests applied to individual institutions are an important tool for evaluating financial resilience. However, financial systems are typically complex, heterogeneous and rapidly changing, raising questions about the adequacy of conventional tests. In this paper, we interpret the current stress test practice from a network perspective, highlighting central counterparties (CCPs) as an example of a critical network hub. Networks that include CCPs involve deep and broad interconnections, making stress testing a challenging task. We propose supplementing both private and supervisory CCP stress tests with a high-frequency indicator constructed from a market-based estimate of the conditional capital shortfall (SRISK) of the CCP's clearing members. Applying our measure to two large CCPs, we analyze how they can transmit and amplify shocks across borders, conditional on the exhaustion of prefunded resources. Our results highlight how the network created by central clearing can act as an important transmission mechanism for shocks emanating from Europe.

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Bibliographic Reference

Berner, R, Cecchetti, S and Schoenholtz, K. 2019. 'Stress Testing Networks: The Case of Central Counterparties'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=13604