Counterparty Credit Risk And The Credit Default Swap Market

Counterparty credit risk has become one of the highest-profile risks facing participants in the financial markets. Despite this, relatively little is known about how counterparty credit risk is actually priced. This issue is examined by studying the CDS spreads quoted by a broad cross-section of dealers selling protection on the same underlying firm. This unique data set allows us to identify directly how the credit risk of the dealer affects the prices of these controversial credit derivatives. Author also found that the pricing of counterparty credit risk became much more significant after the Lehman bankruptcy. Surprisingly, counterparty credit risk is significantly related to the credit protection spreads offered by U.S. dealers, but not to those offered by non-U.S. dealers.