Counterparty Risk and Counterparty Choice in the Credit Default Swap Market
42 Pages Posted: 7 Nov 2016
Date Written: 2016-09-08
We investigate how market participants price and manage counterparty 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 relatively low. Furthermore, we examine the impact of central clearing on CDS pricing. Contrary to the previous literature, but consistent with our main findings on pricing, we find no evidence that central clearing increases transaction spreads.
Keywords: Counterparty credit risk, Credit default swaps, Central clearing
JEL Classification: G12, G13, G24
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