Stressed to the Core: Counterparty Concentrations and Systemic Losses in CDS Markets

34 Pages Posted: 10 Mar 2016

See all articles by Jill Cetina

Jill Cetina

Government of the United States of America - Office of Financial Research

Sriram Rajan

Government of the United States of America - Office of Financial Research

Mark E. Paddrik

Government of the United States of America - Office of Financial Research

Date Written: March 8, 2016

Abstract

Supervisory stress testing to date has focused on the resiliency of large banks to withstand the direct effects of a credit shock. Using data from Depository Trust & Clearing Corporation (DTCC), we apply the Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) supervisory scenarios to evaluate the default of a bank's largest counterparty. We find that indirect effects of this default, through the bank's other counterparties, are larger than the direct impact on the bank. Further, when taken as a whole, the core banking system has a higher concentration to a single counterparty than does any individual bank holding company. Under the 2015 stress, the banking system's counterparty credit concentration is high and corresponds in diversity to a market with just over three firms. Our results are the first to evaluate the credit derivatives market under stress and also underscore the importance of a macroprudential perspective on stress testing.

Keywords: Credit default swaps, stress testing, systemic risk, financial networks, counterparty exposure, contagion

JEL Classification: D85, G01, G13, G20, L14

Suggested Citation

Cetina, Jill and Rajan, Sriram and Paddrik, Mark Endel, Stressed to the Core: Counterparty Concentrations and Systemic Losses in CDS Markets (March 8, 2016). OFR WP 16-01, Available at SSRN: https://ssrn.com/abstract=2744949 or http://dx.doi.org/10.2139/ssrn.2744949

Jill Cetina (Contact Author)

Government of the United States of America - Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

Sriram Rajan

Government of the United States of America - Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

Mark Endel Paddrik

Government of the United States of America - Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

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