  In the last years, increasing efforts have been put into the development of
effective stress tests to quantify the resilience of financial institutions.
Here we propose a stress test methodology for central counterparties based on a
network characterization of clearing members, whose links correspond to direct
credits and debits. This network constitutes the ground for the propagation of
financial distress: equity losses caused by an initial shock with both
exogenous and endogenous components reverberate within the network and are
amplified through credit and liquidity contagion channels. At the end of the
dynamics, we determine the vulnerability of each clearing member, which
represents its potential equity loss. We apply the proposed framework to the
Fixed Income asset class of CC&G, the central counterparty operating in Italy
whose main cleared securities are Italian Government Bonds. We consider two
different scenarios: a distributed, plausible initial shock, as well as a shock
corresponding to the cover 2 regulatory requirement (the simultaneous default
of the two most exposed clearing members). Although the two situations lead to
similar results after an unlimited reverberation of shocks on the network, the
distress propagation is much more hasty in the latter case, with a large number
of additional defaults triggered at early stages of the dynamics. Our results
thus show that setting a default fund to cover insolvencies only on a cover 2
basis may not be adequate for taming systemic events, and only very
conservative default funds, such as CC&G's one, can face total losses due to
the shock propagation. Overall, our network-based stress test represents a
refined tool for calibrating default fund amounts.
