Interest rate swaps clearing and systemic risk

•We develop a model to analyze distress spillover from the OTC interest rate swaps market into the interbank market.•We analyze the impact of margin procyclicality on the propensity for liquidity hoarding.•We show that margin procyclicality can lead to the onset of systemic liquidity shortages.•We s...

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Bibliographic Details
Published in:Finance research letters 2020-03, Vol.33, p.101218, Article 101218
Main Authors: Bakoush, Mohamed, Gerding, Enrico H., Wolfe, Simon
Format: Article
Language:English
Subjects:
Contagion
Funding liquidity risk
Margin procyclicality
Networks
Systemic risk
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Summary:•We develop a model to analyze distress spillover from the OTC interest rate swaps market into the interbank market.•We analyze the impact of margin procyclicality on the propensity for liquidity hoarding.•We show that margin procyclicality can lead to the onset of systemic liquidity shortages.•We show that central clearing may increase systemic liquidity risk. We develop a model to analyze distress spillover from the OTC interest rate swaps (IRS) market into the interbank market due to central clearing and margin requirements. We show that margin procyclicality in the OTC IRS market derived by interest rate volatility can lead to the onset of systemic liquidity shortage in the interbank market. We also show that central clearing may increase systemic liquidity risk due to tight margin requirements.
ISSN:1544-6123
1544-6131
DOI:10.1016/j.frl.2019.06.016