Journal of Economic Interaction and Coordination

, Volume 15, Issue 1, pp 243–281 | Cite as

A simulation analysis of systemic counterparty risk in over-the-counter derivatives markets

  • Yuji SakuraiEmail author
  • Tetsuo Kurosaki
Regular Article


In this paper, we propose a simulation framework to assess systemic risk in over-the-counter derivatives markets. We incorporate credit valuation adjustment (CVA), a mark-to-market estimate of counterparty credit risk booked on a bank’s balance sheet, into an otherwise standard structural model of credit risk. In this model, banks optimally hedge CVA by trading a credit default swap (CDS). The model aims to capture a possible adverse effect called “CDS–CVA feedback loop” from CVA hedging, which could increase CDS spreads due to a lack of liquidity in CDS markets and even further increase CVA because CVA is valued using the default probability extracted from CDS spreads. In order to measure systemic counterparty credit risk, we aggregate CVA across banks and examine how the distribution of systemic counterparty credit risk changes depending on underlying model parameters. We document that the tail risk of CVA increases nonlinearly when the liquidity of CDS markets declines. As an extension, we also model cost of posting collateral and discuss the trade-off between reducing systemic counterparty credit risk, stability of CDS markets and collateral cost.


Mark-to-market accounting Feedback effects Collateral management Margin requirement 



The authors thank anonymous referees for providing detailed comments. Yuji Sakurai is grateful to Ehud Peleg, Eduardo Schwartz, Toshinao Yoshiba, Tetsuya Adachi, Atsushi Okumura, James Schutle and Cooper Killen for their very detailed comments and suggestions. He also thanks Samim Ghamami, Takashi Isogai, Shenje Hshieh and seminar participants from the International Finance and Banking Society in Lisbon and the International Banking, Economics and Finance Association in Colorado, the Finance Ph.D. student seminar at the UCLA Anderson, the conference held at the Bank of Mexico in 2015, WEHIA 2018 in Tokyo, and Brown Bag seminar at the Federal Reserve Bank of Richmond for useful discussions. The views expressed in this paper are those of the authors and not those of the Federal Reserve Bank of Richmond, or the Federal Reserve System, or the Bank of Japan. All remaining errors are ours.


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Copyright information

© Springer-Verlag GmbH Germany, part of Springer Nature 2019

Authors and Affiliations

  1. 1.Federal Reserve Bank of RichmondCharlotteUSA
  2. 2.Bank of JapanTokyoJapan

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