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Answer: Moral hazard Procyclicality
## Explanation Option A correctly describes both concepts: **First concern (decline in willingness to monitor credit risk):** - **Moral Hazard**: When clearing members know the CCP assumes most risks, they have less incentive to carefully monitor counterparty credit risk. This is a classic moral hazard problem where protection reduces monitoring incentives. **Second concern (higher margin requirements during market stress):** - **Procyclicality**: When CCPs increase margin requirements during periods of market stress, this can exacerbate market downturns. Higher margins force participants to post more collateral precisely when liquidity is scarce, creating a procyclical effect that amplifies market volatility. **Why other options are incorrect:** - **Adverse selection** refers to situations where one party has better information than another before a transaction occurs, which doesn't fit the first concern - **Offsetting** refers to netting positions, which is not relevant to margin requirements during stress periods
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Alex Dell, a derivatives trader, has some reservations about the central clearing of OTC derivatives with a central counterparty (CCP). Specifically, he is worried that clearing members' willingness to monitor credit risk may decline since the CCP assumes most of the risks, and that CCPs may increase margin requirements during a period of market stress. Which of the following concepts best describe Dell's reservations?
A
Moral hazard Procyclicality
B
Adverse selection Offsetting
C
Moral hazard Offsetting
D
Adverse selection Procyclicality
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