DP12694 Safe Haven CDS Premiums

Author(s): Sven Klinger, David Lando
Publication Date: February 2018
Keyword(s): capital charges, CDS premiums, CDS-bond basis, CVA
JEL(s): F34, G12, G15
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12694

Credit Default Swaps can be used to lower capital requirements of dealer banks who enter into uncollateralized derivatives positions with sovereigns. We show in a model that the regulatory incentive to obtain capital relief makes CDS contracts valuable to dealer banks and empirically that, consistent with the use of CDS for regulatory purposes, there is a disconnect between changes in bond yield spreads and in CDS premiums especially for safe sovereigns. Additional empirical tests related to volumes of contracts outstanding, effects of regulatory proxies, and the corporate bond and CDS markets support that CDS contracts are used for capital relief.