Concentrated Capital Losses and the Pricing of Corporate Credit Risk

In studying the U.S. credit default swap (CDS) market, Professor Siriwardane has discovered that the selling of CDS protection is extremely concentrated, with five sellers accounting for nearly half the market. Further, in contrast to what neoclassical theory suggests, he finds that capital losses among the largest sellers cause the price of default insurance to rise across the entire economy. In addition, he shows that the concentration of the market creates fragility—higher concentration leads to more volatility in the market.