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Counterparty Credit Limits: The Impact of a Risk-Mitigation Measure on Everyday Trading

Counterparty Credit Limits: The Impact of a Risk-Mitigation Measure on Everyday Trading A counterparty credit limit (CCL) is a limit that is imposed by a financial institution to cap its maximum possible exposure to a specified counterparty. CCLs help institutions to mitigate counterparty credit risk via selective diversification of their exposures. In this paper, we analyse how CCLs impact the prices that institutions pay for their trades during everyday trading. We study a high-quality data set from a large electronic trading platform in the foreign exchange spot market that allows institutions to apply CCLs. We find empirically that CCLs had little impact on the vast majority of trades in this data set. We also study the impact of CCLs using a new model of trading. By simulating our model with different underlying CCL networks, we highlight that CCLs can have a major impact in some situations. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Applied Mathematical Finance Taylor & Francis

Counterparty Credit Limits: The Impact of a Risk-Mitigation Measure on Everyday Trading

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Counterparty Credit Limits: The Impact of a Risk-Mitigation Measure on Everyday Trading

Abstract

A counterparty credit limit (CCL) is a limit that is imposed by a financial institution to cap its maximum possible exposure to a specified counterparty. CCLs help institutions to mitigate counterparty credit risk via selective diversification of their exposures. In this paper, we analyse how CCLs impact the prices that institutions pay for their trades during everyday trading. We study a high-quality data set from a large electronic trading platform in the foreign exchange spot market that...
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Publisher
Taylor & Francis
Copyright
© 2021 Informa UK Limited, trading as Taylor & Francis Group
ISSN
1466-4313
eISSN
1350-486X
DOI
10.1080/1350486X.2021.1893770
Publisher site
See Article on Publisher Site

Abstract

A counterparty credit limit (CCL) is a limit that is imposed by a financial institution to cap its maximum possible exposure to a specified counterparty. CCLs help institutions to mitigate counterparty credit risk via selective diversification of their exposures. In this paper, we analyse how CCLs impact the prices that institutions pay for their trades during everyday trading. We study a high-quality data set from a large electronic trading platform in the foreign exchange spot market that allows institutions to apply CCLs. We find empirically that CCLs had little impact on the vast majority of trades in this data set. We also study the impact of CCLs using a new model of trading. By simulating our model with different underlying CCL networks, we highlight that CCLs can have a major impact in some situations.

Journal

Applied Mathematical Finance – Taylor & Francis

Published: Nov 1, 2020

Keywords: Counterparty credit limits; counterparty credit risk; foreign exchange; price formation; market design

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