Central Clearing of OTC Derivatives : Bilateral vs Multilateral Netting

We study the impact of central clearing of over-the-counter (OTC) transactions on counterparty exposures in a market with OTC transactions across several asset classes with heterogeneous characteristics. We find that the impact, on total expected interdealer exposure, of introducing a central counterparty (CCP) for a single class of OTC derivatives is sensitive to assumptions on heterogeneity of asset classes in terms of `riskyness' of the asset class as well as correlation of exposures across asset classes. In particular, while an analysis assuming independent, homogeneous exposures suggests that central clearing is efficient only if one has an unrealistically high number of participants, the opposite conclusion is reached if differences in riskyness and correlation across asset classes are realistically taken into account. Empirically plausible specifications of these parameters lead to the conclusion that the gain from multilateral netting in a CCP overweighs the loss of netting across asset classes in bilateral netting agreements. When a CCP exists for interest rate derivatives, adding a CCP for credit derivatives is shown to decrease overall exposures. These findings are shown to be robust to the choice of distribution for OTC derivatives exposures