Do Central Counterparts Improve the Stability of Derivatives Market? Some Evidence from an Agent-Based Model

Abstract

In the aftermath of the 2007-08 financial crises, regulatory reforms of the financial system came to include a role for central counterparts, which are expected to improve the stability of derivatives markets. Using an agent-based model simulation, this study suggests that central counterparts help achieving this policy objective. The introduction of central counterparts, however, can also stimulate novel patterns of industrial dynamics, especially in the form of possible fragmentation of the derivatives market into segregated networks around different central counterparts. It seems, moreover, that even the presence of central counterparts does not provide full safeguard to the preservation of the stability of the financial system, depending on the occurrence of relatively high credit default losses.