Does central clearing affect counterparty risk and liquidity risk in the sovereign CDS market?

Abstract

Central counterparty clearing houses (CCPs) are highly regulated intermediaries and risk management providers for OTC transactions. This paper analyzes the impact of CCP clearing on the pricing of sovereign single-name credit default swaps (CDS) using a global sample between 2010 and 2017. The results indicate that a large portion of daily CCP cleared contracts makes CDS spreads insignificant to counterparty risk and thus mitigates a major source of systemic risk in the CDS market. In contrast, CCP clearing has no significant effect on CDS market liquidity. Moreover, CDS spreads are mainly driven by local factors as opposed to global factors.