Pricing Implication of Centrality in an OTC derivative Market: An Empirical Analysis Using Transaction-Level CDS Data

Abstract

Using the transaction-level records accounting for the universe of the credit default swap (CDS) contracts in Japan, we document whether and how (if any) the relative centrality of sellers to buyers affects CDS price. First, our panel estimation, which comprehensively controls for the pricing factors (e.g., entity's risk, counter-party risk, notional, and maturity) considered in practice, suggests that CDS price becomes higher as the relative centrality of sellers to buyers becomes higher. Second, this centrality premium is observed mainly in the market with higher credit risk and further increases when the buyers attempt to unwind their short position made in the past. Third, deeper trade relations between sellers and buyers result in centrality discount (premium) in the market with higher (lower) credit risk. These results suggest the tradeoff between the cost of maintaining relationship in good periods and the benefit of securing cheap access to CDS in bad periods.