  We study the impact of central clearing of over-the-counter (OTC)
transactions on counterparty exposures in a market with OTC transactions across
several asset classes with heterogeneous characteristics. The impact of
introducing a central counterparty (CCP) on expected interdealer exposure is
determined by the tradeoff between multilateral netting across dealers on one
hand and bilateral netting across asset classes on the other hand. We find this
tradeoff to be sensitive to assumptions on heterogeneity of asset classes in
terms of `riskyness' of the asset class as well as correlation of exposures
across asset classes. In particular, while an analysis assuming independent,
homogeneous exposures suggests that central clearing is efficient only if one
has an unrealistically high number of participants, the opposite conclusion is
reached if differences in riskyness and correlation across asset classes are
realistically taken into account. We argue that empirically plausible
specifications of model parameters lead to the conclusion that central clearing
does reduce interdealer exposures: the gain from multilateral netting in a CCP
overweighs the loss of netting across asset classes in bilateral netting
agreements. When a CCP exists for interest rate derivatives, adding a CCP for
credit derivatives is shown to decrease overall exposures. These findings are
shown to be robust to the statistical assumptions of the model as well as the
choice of risk measure used to quantify exposures.
