The impact of central clearing on counterparty risk, liquidity, and trading: Evidence from the credit default swap market

This paper examines the impact of central clearing on the credit default swap (CDS) market using a sample of voluntarily cleared single-name contracts. Consistent with central clearing reducing counterparty risk, CDS spreads increase around the commencement of central clearing and are lower than set...

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Bibliographic Details
Published in:Journal of financial economics Vol. 112; no. 1; pp. 91 - 115
Main Authors: Loon, Yee Cheng, Zhong, Zhaodong Ken
Format: Journal Article
Language:English
Published: Amsterdam Elsevier B.V 01.04.2014
Elsevier Sequoia S.A
Subjects:
Bond markets
Bonds
Central clearing
Clearing
Clearinghouses
Counterparty risk
Credit
Credit default swap
Credit default swaps
Credit risk
Investment analysis
Liquidity
Markets
Personal finance
Risk
Risk management
Risk theory
Spread
Studies
Systemic risk
Transparency
Central clearing
Counterparty risk
G13
Liquidity
G12
Systemic risk
G14
Credit default swap
G28
G18
ISSN:0304-405X, 1879-2774
Online Access:Get full text
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Summary:This paper examines the impact of central clearing on the credit default swap (CDS) market using a sample of voluntarily cleared single-name contracts. Consistent with central clearing reducing counterparty risk, CDS spreads increase around the commencement of central clearing and are lower than settlement spreads published by the central clearinghouse. Furthermore, the relation between CDS spreads and dealer credit risk weakens after central clearing begins, suggesting a lowering of systemic risk. These findings are robust to controls for frictions in both CDS and bond markets. Finally, matched sample analysis reveals that the increased post-trade transparency following central clearing is associated with an improvement in liquidity and trading activity.
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ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2013.12.001