Agostino Capponi


Speaker: Agostino Capponi
Title: Counterparty Risk and Network Formation in Over-the-Counter Markets
Affiliation: Columbia University
Date: Friday, March 30, 2018
Place and Time: Room 101, Love Building, 3:35-4:30 pm
Refreshments: Room 204, Love Building, 3:00 pm

Abstract. We study how banks manage default risk before bilaterally negotiating the quantities and prices of over-the-counter contracts. We show that the costly actions exerted by banks to reduce their default probabilities are ine fficient. Negative network externalities due to counterparty concentration may lead banks to reduce their default probabilities even below the social optimum. The model provides new implications that are supported by empirical evidence: (i) intermediation is done by low-risk banks with medium initial exposure; (ii) high-risk banks with low initial exposure never engage in perfect risk sharing; and (iii) post-trade exposures are more heterogeneous if banks are riskier.

(This is joint work with Christoph Frei.)