Counterparty Credit Risk and the Credit Default Swap Market
American Century Investments
Mendoza College of Business, University of Notre Dame
Francis A. Longstaff
University of California, Los Angeles (UCLA) - Finance Area; National Bureau of Economic Research (NBER)
March 1, 2011
Journal of Financial Economics (JFE), Vol. 103, No. 2, 2012
Counterparty credit risk has become one of the highest-profile risks facing participants in the financial markets. Despite this, relatively little is known about how counterparty credit risk is actually priced. We examine this issue using an extensive proprietary data set of contemporaneous CDS transaction prices and quotes by 14 different CDS dealers selling credit protection on the same underlying firm. This unique cross-sectional data set allows us to identify directly how dealers’ credit risk affects the prices of these controversial credit derivatives. We find that counterparty credit risk is priced in the CDS market. The magnitude of the effect, however, is vanishingly small and is consistent with a market structure in which participants require collateralization of swap liabilities by counterparties.
Number of Pages in PDF File: 14
Keywords: Counterparty Credit Risk, CDSAccepted Paper Series
Date posted: May 6, 2011 ; Last revised: December 17, 2012
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