We present a network model for investigating the impact on systemic risk of central clearing of over the counter (OTC) credit default swaps (CDS). We model contingent cash flows resulting from CDS and other OTC derivatives by a multi-layered network with a core-periphery structure, which is flexible enough to reproduce the gross and net exposures as well as the heterogeneity of market shares of participating institutions. We analyze illiquidity cascades resulting from liquidity shocks and show that the contagion of illiquidity takes place along a sub-network constituted by links identified as ’critical receivables’. A key role is played by the long intermediation chains inherent to the structure of the OTC network, which may turn into chains of critical receivables. We calibrate our model to data representing net and gross OTC exposures of large dealer banks and use this model to investigate the impact of central clearing on network stability. We find that, when interest rate swaps are cleared, central clearing of credit default swaps through a well-capitalized CCP can reduce the probability and the magnitude of a systemic illiquidity spiral by reducing the length of the chains of critical receivables within the financial network. These benefits are reduced, however, if some large intermediaries are not included as clearing members.

We examine the effects on a financial network of clearing all contracts though a central node (CN), thereby transforming the original network into a star-shaped one. The CN is capitalized with exte...

We introduce threshold growth in the classical threshold contagion model, or equivalently a network of Cramér-Lundberg processes in which nodes have downward jumps when there is a failure of a neighboring node. Choosing the configuration model as underlying graph, we prove fluid limits for the baseline model, as well as extensions to the directed case, state-dependent interarrival times and the case of growth driven by upward jumps. We obtain explicit ruin probabilities for the nodes according to their characteristics: initial threshold and in- (and out-) degree. We then allow nodes to choose their connectivity by trading off link benefits and contagion risk. We define a rational equilibrium concept in which nodes choose their connectivity according to an expected failure probability of any given link and then impose condition that the expected failure probability coincides with the actual failure probability under the optimal connectivity. We show existence of an asymptotic equilibrium and convergence of the sequence of equilibria on the finite networks. In particular, our results show that systems with higher overall growth may have higher failure probability in equilibrium.