Counterparty Risk and Counterparty Choice in the Credit Default Swap Market

RePEc Short ID: pgo10
ORCID iD: 0000-0002-5229-4608

Du, Wenxin; Gadgil, Salil; Gordy, Michael B.; Vega, Clara

doi:10.17016/FEDS.2016.087

Working Paper

Counterparty Risk and Counterparty Choice in the Credit Default Swap Market

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.

Keywords: Counterparty credit risk; Credit default swaps; Central clearing;

JEL Classification: G12; G13; G24;

https://doi.org/10.17016/FEDS.2016.087