Those who claim it is cheaper to engage in derivatives over the counter than through a central clearing counterparty are not taking the cost of credit risk into account, according to a study by the European Energy Exchange.
The report finds it is cheaper on average to use a central
clearing house, which theoretically eliminates counterparty
risk, than it is to buy an OTC derivative and hedge the
counterparty risk exposure using a credit default swap.
The study takes account of different costs for OTC and
exchange trading. For each, it includes transaction costs and
the cost of protection against default. For exchange trading it
also includes the cost of liquidity needed for posting
additional margin and variation margin.
The calculations assume that the contract is held for one
year. During this time, the cumulative total daily margin paid
to a central counterparty is on average smaller than the
premium paid to the seller of a credit default swap to hedge
the counterparty risk. This obviously varies depending on the
counterparty’s credit rating.
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