Contagion in the CDS Market

H Peyton Young, Mark Paddrik () and Sriram Rajan

No 821, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: Abstract This paper analyzes counterparty exposures in the credit default swaps market and examines the impact of severe credit shocks on the demand for variation margin, which are the payments that counterparties make to offset price changes. We employ the Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) shocks and estimate their impact on the value of CDS contracts and the variation margin owed. Large and sudden demands for variation margin may exceed a firm's ability to pay, leading some firms to delay or forego payments. These shortfalls can become amplified through the network of exposures. Of particular importance in cleared markets is the potential impact on the central counterparty clearing house. Although a central node according to conventional measures of network centrality, the CCP contributes less to contagion than do several peripheral firms that are large net sellers of CDS protection. During a credit shock these firms can suffer large shortfalls that lead to further shortfalls for their counterparties, amplifying the initial shock.

Keywords: Credit default swaps; stress testing; systemic risk; financial networks (search for similar items in EconPapers)
JEL-codes: D85 G01 G17 L14 (search for similar items in EconPapers)
Date: 2017-01-24
New Economics Papers: this item is included in nep-fmk, nep-net and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Related works:
Working Paper: Contagion in the CDS Market (2016)
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