Working Paper: NBER ID: w20459
Authors: Asaf Bernstein; Eric Hughson; Marc D. Weidenmier
Abstract: Heightened counterparty risk during the recent financial crisis has raised questions about the role clearinghouses play in global financial stability. Empirical identification of the effect of centralized clearing on counterparty risk is challenging because of the co-incidence of macro-economic turbulence and the introduction of clearinghouses. We overcome these concerns by examining a novel historical experiment, the establishment of a clearinghouse on the New York Stock Exchange (NYSE) in 1892. During this period the largest NYSE stocks were also listed on the Consolidated Stock Exchange (CSE), which already had a clearinghouse. Using identical securities on the CSE as a control, we find that the introduction of clearing reduced annualized volatility of NYSE returns by 90-173bps and increased asset values. Prior to clearing, shocks to overnight lending rates reduced the value of stocks on the NYSE, relative to identical stocks on the CSE, but this was no longer true after the establishment of clearing. We also show that at least ½ of the average reduction in counterparty risk on the NYSE is driven by a reduction in contagion risk - the risk of a cascade of broker defaults. Our results indicate that clearing can cause a significant improvement in market stability and value through a reduction in network contagion and counterparty risk.
Keywords: counterparty risk; clearinghouse; financial stability
JEL Codes: G0; G01; G1; G12; G18; G2; G23; G28; N0; N2; N21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Introduction of NYSE clearinghouse (Y20) | Reduction in annualized volatility of NYSE returns (G17) |
| Reduction in counterparty risk (G33) | Reduction in annualized volatility of NYSE returns (G17) |
| Reduction in contagion risk (F65) | Reduction in counterparty risk (G33) |
| Introduction of NYSE clearinghouse (Y20) | Increase in asset values of NYSE stocks (G10) |
| Shocks to overnight lending rates (E43) | No significant effects on NYSE prices post-clearing (G14) |
| Introduction of NYSE clearinghouse (Y20) | Reduction in broker defaults (G24) |