Counterparty Credit Risk and the Effectiveness of Banking Regulation
26 Pages Posted: 12 Jul 2018 Last revised: 6 Nov 2018
Date Written: June 26, 2018
We investigate how counterparty credit risk influences the prices of over-the-counter CDS contracts using confidential transaction level data for practically all Dutch trades. We confirm our prior of a significant negative relationship between the credit worthiness of the CDS seller and the price of the CDS contract. We find that an increase of 100 basis points in the credit spread of the seller, decreases the price of the CDS contract by 7.2 basis points. Also, the larger the size of the CDS contract the lower the price of the CDS contract. Finally, we find that regulatory exemptions have a statistically significant but economically negligible impact on CDS pricing: Transactions exempted from banking capital requirements for Credit Valuation Adjustment risk – mostly banks transacting with non-financial institutions, sovereigns and pension funds – trade 0.14 basis points lower, all else equal.
Keywords: OTC market, counterparty credit risk, credit default swap
JEL Classification: G10, G12, G14, G20, G23
Suggested Citation: Suggested Citation