Sven Seuken und Steffen Schuldenzucker, University of Zurich, Clearing Payments in Financial Networks with Credit Default Swaps

We consider the problem of clearing a system of interconnected banks that have been exposed to a shock on their assets. Eisenberg and Noe (2001) and Rogers and Veraart (2013) showed that when banks can only enter into debt contracts with each other, then there always exists a unique Pareto efficient clearing payment vector and it can be computed in polynomial time.
In the present paper, we show that the situation changes radically when banks can also enter into credit default swaps (CDSs). We first prove the surprising result that with CDSs, there may not even be a clearing vector at all. This implies that the value of a contract may not be well-defined. Furthermore, we prove that even determining whether a clearing vector exists is computationally infeasible in the worst case (NP-hard). We then develop a new analysis framework to derive constraints on the contract space under which these problems are alleviated. Our results can be used to inform the discussion on different policy proposals. We show that routing all contracts via a central counterparty would not even guarantee existence. In contrast, we show that banning \naked" (speculative) CDSs would re-establish an existence guarantee for a unique Pareto efficient clearing payment vector.