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Counterparty credit risk and the effectiveness of banking regulation

Iman Lelyveld and Sinziana Kroon

DNB Working Papers from Netherlands Central Bank, Research Department

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 (search for similar items in EconPapers)
JEL-codes: G10 G12 G14 G20 G23 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cba, nep-knm and nep-rmg
Date: 2018-06
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Persistent link: https://EconPapers.repec.org/RePEc:dnb:dnbwpp:599

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