Counterparty Risk and Counterparty Choice in the Credit Default Swap Market

Abstract

We investigate how market participants price and manage counterparty credit risk in the post-crisis period using confidential trade repository data on single-name credit default swap (CDS) transactions. We find that counterparty risk has a modest impact on the pricing of CDS contracts, but a large impact on the choice of counterparties. We show that market participants are significantly less likely to trade with counterparties whose credit risk is highly correlated with the credit risk of the reference entities and with counterparties whose credit quality is low. Our results suggest that credit rationing may arise under wider circumstances than previously recognized.

Keywords: Counterparty Credit Risk, Credit Default Swaps, Central Clearing

JEL Classification: G12, G13, G24