Multidimensional Effects of Central Clearing on CDS Market Liquidity and Their Economic Channels – A Regression Discontinuity Approach

71 Pages Posted: 15 Apr 2020 Last revised: 15 Sep 2020

Date Written: March 25, 2020

Abstract

In this study, I analyze the effect of central clearing on market liquidity in the CDS market. This study extends existing literature by using semi-parametric and non-parametric regression discontinuity designs (RDD) in order to isolate the effect of central clearing on measures of market tightness, market depth and market resiliency. I find evidence for a decrease in absolute bid-ask spreads with the beginning of central clearing and an increase in gross trading volume. Bid-ask spread resiliency decreases with the beginning of central clearing. These effect differ across contracts depending on their fundamental risk and liquidity risk. I show that counterparty risk and inventory costs may partly explain the effects of central clearing on CDS market liquidity. Especially the lower relevance of counterparty risk and lower regulatory capital charges seem to affect positively dealer competition and risk-taking capacity in the CDS market.

Keywords: Central clearing, credit default swaps, market liquidity, regression discontinuity

JEL Classification: G12, G15, G18, G23, G28

Suggested Citation

Schoenemann, Gregor, Multidimensional Effects of Central Clearing on CDS Market Liquidity and Their Economic Channels – A Regression Discontinuity Approach (March 25, 2020). Available at SSRN: https://ssrn.com/abstract=3561116 or http://dx.doi.org/10.2139/ssrn.3561116

Gregor Schoenemann (Contact Author)

University of Hohenheim ( email )

Fruwirthstr. 48
Stuttgart, 70599
Germany

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