Counterparty Risk and Counterparty Choice in the Credit Default Swap Market

42 Pages Posted: 7 Nov 2016 Last revised: 24 Jun 2021

See all articles by Wenxin Du

Wenxin Du

Harvard Business School

Salil Gadgil

Office of Financial Research, U.S. Department of the Treasury

Michael B. Gordy

Board of Governors of the Federal Reserve System

Clara Vega

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: September, 2016

Abstract

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.

JEL Classification: G12, G13, G24

Suggested Citation

Du, Wenxin and Gadgil, Salil and Gordy, Michael B. and Vega, Clara, Counterparty Risk and Counterparty Choice in the Credit Default Swap Market (September, 2016). FEDS Working Paper No. 2016-87, Available at SSRN: https://ssrn.com/abstract=2864846 or http://dx.doi.org/10.17016/FEDS.2016.087

Wenxin Du (Contact Author)

Harvard Business School ( email )

Salil Gadgil

Office of Financial Research, U.S. Department of the Treasury ( email )

717 14th St NW
Washington, DC 20005
United States

Michael B. Gordy

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-452-3705 (Phone)

HOME PAGE: http://https://www.federalreserve.gov/econres/michael-b-gordy.htm

Clara Vega

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/research/staff/vegaclarax.htm

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