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Stressed to the core: Counterparty concentrations and systemic losses in CDS markets

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  • Cetina, Jill
  • Paddrik, Mark
  • Rajan, Sriram

Abstract

U.S. supervisory stress tests to date have focused on the resilience of large banks to withstand the direct effects of credit and trading shocks. Using data from Depository Trust & Clearing Corporation (DTCC), we apply the Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) supervisory scenarios to evaluate the default of a bank's largest counterparty. We find that indirect effects of this default, through the bank's other counterparties, may be larger than the direct impact on the bank. Further, when taken as a whole, the core banking system has a higher exposure concentration to a single counterparty than does any individual bank holding company. We find that the U.S. banking system's counterparty exposure concentration has risen over the 2013–2015 period. Under the 2015 CCAR this corresponds to a market diversity with just over three counterparties under stress. Our results are the first to evaluate the U.S. credit derivatives market under stress and underscore the importance of a macroprudential perspective on stress testing.

Suggested Citation

  • Cetina, Jill & Paddrik, Mark & Rajan, Sriram, 2018. "Stressed to the core: Counterparty concentrations and systemic losses in CDS markets," Journal of Financial Stability, Elsevier, vol. 35(C), pages 38-52.
    • Handle: RePEc:eee:finsta:v:35:y:2018:i:c:p:38-52
    DOI: 10.1016/j.jfs.2016.10.012
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    Citations

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    Cited by:

    1. Mark Paddrik & H. Peyton Young, 2016. "Contagion in the CDS Market," Working Papers 16-12, Office of Financial Research, US Department of the Treasury.
    2. Iman van Lelyveld, 2017. "The use of derivatives trade repository data: possibilities and challenges," IFC Bulletins chapters, in: Bank for International Settlements (ed.), Data needs and Statistics compilation for macroprudential analysis, volume 46, Bank for International Settlements.
    3. Zema, Sebastiano Michele, 2022. "Uncovering the network structure of non-centrally cleared derivative markets: evidences from regulatory data," Working Paper Series 2721, European Central Bank.
    4. Bardoscia, Marco & Ferrara, Gerardo & Vause, Nicholas & Yoganayagam, Michael, 2021. "Simulating liquidity stress in the derivatives market," Journal of Economic Dynamics and Control, Elsevier, vol. 133(C).
    5. Abbassi, Puriya & Brownlees, Christian & Hans, Christina & Podlich, Natalia, 2017. "Credit risk interconnectedness: What does the market really know?," Journal of Financial Stability, Elsevier, vol. 29(C), pages 1-12.
    6. Sebastiano Michele Zema, 2023. "Uncovering the network structure of non-centrally cleared derivative markets: evidence from large regulatory data," Empirical Economics, Springer, vol. 65(4), pages 1799-1822, October.
    7. Augustin, Patrick & Sokolovski, Valeri & Subrahmanyam, Marti G. & Tomio, Davide, 2022. "How sovereign is sovereign credit risk? Global prices, local quantities," Journal of Monetary Economics, Elsevier, vol. 131(C), pages 92-111.
    8. Zhao, Hong & Li, Jiayi & Lei, Yiqing & Zhou, Mingming, 2022. "Risk spillover of banking across regions: Evidence from the belt and road countries," Emerging Markets Review, Elsevier, vol. 52(C).
    9. Pliszka, Kamil, 2021. "System-wide and banks' internal stress tests: Regulatory requirements and literature review," Discussion Papers 19/2021, Deutsche Bundesbank.
    10. Office of Financial Research (ed.), 2017. "2017 Financial Stability Report," Reports, Office of Financial Research, US Department of the Treasury, number 17-2.

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    More about this item

    Keywords

    Credit default swaps; Stress testing; Systemic risk; Financial networks; Counterparty exposure; Contagion;
    All these keywords.

    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • G01 - Financial Economics - - General - - - Financial Crises
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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