Dominic O'Kane: Concerns about systemic credit risk in the financial system due to the OTC derivatives market has encouraged the use of counterparty credit risk mitigation techniques, including the use of compression.
Affiliated Professor in Finance, EDHEC Business School
In compression, market participants share position information via a third party company, TriOptima, which then proposes a set of trades which will “compress” their multilateral exposures. In this paper we propose and analyse a set of optimal compression algorithms for fungible derivatives. We find that they all perform extremely well across a range of criteria and we discuss their relative attributes. Our focus is on the CDS market, although the methods analysed here can be applied to other OTC derivative markets. We argue that, if done optimally, compression is an effective counterparty risk mitigation technique that should be encouraged by regulators, especially as we show that the benefits increase dramatically with the number of participants.
|Research Cluster :||Finance|