Title: Risk and the credit default swap market
Authors: Tuomas Peltonen - European Systemic Risk Board (Germany) [presenting]
Marco Derrico - University of Zurich (Switzerland)
Stefano Battiston - UZH (Switzerland)
Martin Scheicher - ECB (Germany)
Abstract: A Credit Default Swap (CDS) is a contract built upon the transfer of underlying risk and the creation of counterparty risk. We provide theoretical and empirical results about the complex network arising from the set of risk transfers in the CDS network. First, we introduce the notion of flow-of-risk and provide sufficient conditions fora bow-tie network architecture to endogenously emerge as a result of intermediation. We show that the probability of a widespread systemic loss due to counterparty risk is higher in a bow-tie architecture than in more fragmented network structures. Empirically, we use a unique global dataset of CDS bilateral exposures on major sovereign and financial reference entities in the years 2011 - 2014. We find that the CDS network shows precisely a bow-tie network architecture for the vast majority of reference entities. The flow-of-risk originates from a large number of Ultimate Risk Sellers (URSs) and ends up in a very few leading Ultimate Risk Buyers (URBs), the largest majority of which are non-banks. The analysis of the CDS portfolio composition of the URBs shows a high level of concentration in the market; in particular, the top URBs often show large exposures to potentially correlated reference entities.