Counterparty Credit Risk and the Effectiveness of Banking Regulation

26 Pages Posted: 12 Jul 2018 Last revised: 6 Nov 2018

See all articles by Iman van Lelyveld

Iman van Lelyveld

De Nederlandsche Bank; Vrije Universiteit Amsterdam

Sînziana Kroon

De Nederlandsche Bank

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Date Written: June 26, 2018

Abstract

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

van Lelyveld, Iman and Kroon Petrescu, Sînziana, Counterparty Credit Risk and the Effectiveness of Banking Regulation (June 26, 2018). De Nederlandsche Bank Working Paper No. 599. Available at SSRN: https://ssrn.com/abstract=3205252 or http://dx.doi.org/10.2139/ssrn.3205252

Iman van Lelyveld

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Vrije Universiteit Amsterdam ( email )

Netherlands

Sînziana Kroon Petrescu (Contact Author)

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

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