Fernando Cerezetti, Emmanouil Karimalis, Ujwal Shreyas and Anannit Sumawong
When a trade is executed and cleared though a central counterparty (CCP), the CCP legally becomes a buyer for every seller and a seller for every buyer. When a CCP member defaults, the need to establish a matched book for cleared positions means the defaulter’s portfolio needs to be closed out. The CCP then faces a central question: what hedges should be executed before the portfolio is liquidated so as to minimize the costs of closeout? In a recent paper, we investigate how distinct hedging strategies may expose a CCP to different sets of risks and costs during the closeout period. Our analysis suggests that CCPs should carefully take into account these strategies when designing their default management processes.