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Counterparty Risk and Counterparty Choice in the Credit Default Swap Market

Author

Listed:
  • Wenxin Du

    (Columbia Business School, New York, New York 10027)

  • Salil Gadgil

    (Office of Financial Research, U.S. Department of the Treasury, Washington, DC 20220)

  • Michael B. Gordy

    (Federal Reserve Board, Washington, DC 20551)

  • Clara Vega

    (Federal Reserve Board, Washington, DC 20551)

Abstract

We investigate how market participants price and manage counterparty credit risk 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. For contracts ineligible for central clearing, 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 low. For clearable contracts, we find that nondealers are more likely to clear during a crisis and less likely to clear when the reference entity is a large U.S. dealer or a sovereign.

Suggested Citation

  • Wenxin Du & Salil Gadgil & Michael B. Gordy & Clara Vega, 2024. "Counterparty Risk and Counterparty Choice in the Credit Default Swap Market," Management Science, INFORMS, vol. 70(6), pages 3808-3826, June.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:6:p:3808-3826
    DOI: 10.1287/mnsc.2023.4870
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