Credit Default Swaps
Friday, Jan. 5, 2018 10:15 AM - 12:15 PM
- Chair: Greg Duffee, Johns Hopkins University
Market Structure and Transaction Costs of Index CDSs
AbstractUsing transaction data, we study the two-tiered structure of the index CDS market
after the implementation of the Dodd-Frank Act. We identify dealer-to-client (D2C)
trades and interdealer (D2D) trades. Average transaction costs are higher for D2C
trades, reflecting higher average price impact. D2C trades Granger-cause D2D trades
consistent with the interdealer market being used for managing inventory risk. Unique
order-book data show that D2D transaction costs and price impacts vary across trading
protocols, with mid-market matching and workup attracting liquidity-motivated trades.
D2C prices are typically better than those available on the main interdealer limit order
book, which may explain the endurance of the two-tiered market structure.
Mitigating Counterparty Risk
AbstractThis paper provides initial evidence on counterparty risk-mitigation activities of financial institutions on the basis of Depository Trust and Clearing Corporation's (DTCC) proprietary bilateral credit default swap transactions and positions. We show that financial institutions that are active buyers of protection from a specific counterparty undertake successive contracts and purchase protection written on them, even avoiding wrong-way risk mitigation. Higher stock return and CDS price volatility, lower past stock returns, and higher CDS prices of the counterparty are shown to have an increasing effect on the hedging behaviour against the counterparty. As the current regulatory frameworks explicitly formulate any protection purchase on the counterparty would diminish the required capital, this type of risk mitigation could follow regulatory capital relief motives and provides a viable hedging instrument beyond receiving coverage through collateral.
Credit Derivatives and Firm Investment
AbstractWe examine the effect of credit default swap (CDS) trading on firm investment, finding evidence of a post-CDS introduction drop in debt issuance and M&A activities, which remains robust to propensity score matching and instrumenting CDS introduction using lenders' FX hedging activities. Further analysis reveals a CDS introduction-year increase in debt financing and investment, and suggests that the ex ante commitment benefit of CDS in reducing strategic default, the ex post increase in bankruptcy risk and debt overhang, and the credit supply expansion by banks using CDS to reduce regulatory capital requirements all play a role in explaining these results.
- G1 - General Financial Markets