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Credit default swaps and risk-shifting

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  • Campello, Murillo
  • Matta, Rafael

Abstract

Credit default swaps (CDSs) are thought to ease borrowing by protecting lenders against default. This paper develops a model of the demand for CDS when borrowers choose the riskiness of investment and verification is imperfect. The model shows that CDSs may lead to risk-shifting, increasing the probability of default. Our model provides new insights into the role of CDS during the recent financial crisis.

Suggested Citation

  • Campello, Murillo & Matta, Rafael, 2012. "Credit default swaps and risk-shifting," Economics Letters, Elsevier, vol. 117(3), pages 639-641.
    • Handle: RePEc:eee:ecolet:v:117:y:2012:i:3:p:639-641
    DOI: 10.1016/j.econlet.2012.08.013
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    References listed on IDEAS

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    1. Henry T. C. Hu & Bernard Black, 2008. "Debt, Equity and Hybrid Decoupling: Governance and Systemic Risk Implications," European Financial Management, European Financial Management Association, vol. 14(4), pages 663-709, September.
    2. Patrick Bolton & Martin Oehmke, 2011. "Credit Default Swaps and the Empty Creditor Problem," The Review of Financial Studies, Society for Financial Studies, vol. 24(8), pages 2617-2655.
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    Citations

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    Cited by:

    1. Nina Boyarchenko & Anna M. Costello & Or Shachar, 2018. "Credit Market Choice," Liberty Street Economics 20181017, Federal Reserve Bank of New York.
    2. Amin, Abu & Jain, Pawan & Upadhyay, Arun, 2022. "CDS, CEO compensation, and firm value," Finance Research Letters, Elsevier, vol. 46(PB).
    3. Colonnello, Stefano & Efing, Matthias & Zucchi, Francesca, 2019. "Shareholder bargaining power and the emergence of empty creditors," Journal of Financial Economics, Elsevier, vol. 134(2), pages 297-317.
    4. Arping, Stefan, 2014. "Credit protection and lending relationships," Journal of Financial Stability, Elsevier, vol. 10(C), pages 7-19.
    5. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    6. Colonnello, Stefano & Efing, Matthias & Zucchi, Francesca, 2016. "Empty creditors and strong shareholders: The real effects of credit risk trading," IWH Discussion Papers 10/2016, Halle Institute for Economic Research (IWH).
    7. Hans Degryse & Yalin Gündüz & Kuchulain O'Flynn & Steven Ongena, 2020. "Identifying Empty Creditors with a Shock and Micro-Data," Swiss Finance Institute Research Paper Series 20-15, Swiss Finance Institute.
    8. Li, Jay Y. & Tang, Dragon Yongjun, 2022. "Product market competition with CDS," Journal of Corporate Finance, Elsevier, vol. 73(C).
    9. Gan, Liu & Yang, Zhaojun, 2024. "Financial decisions involving credit default swaps over the business cycle," Journal of Economic Dynamics and Control, Elsevier, vol. 161(C).
    10. Salomao, Juliana, 2017. "Sovereign debt renegotiation and credit default swaps," Journal of Monetary Economics, Elsevier, vol. 90(C), pages 50-63.
    11. Campello, Murillo & Matta, Rafael, 2020. "Investment risk, CDS insurance, and firm financing," European Economic Review, Elsevier, vol. 125(C).
    12. Naceur Essaddam & Miran Hossain & Tashfeen Hussain, 2023. "Do credit default swaps impact lenders’ monitoring of loans?," Review of Quantitative Finance and Accounting, Springer, vol. 61(2), pages 567-600, August.

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    More about this item

    Keywords

    CDS; Risk-shifting; Financing efficiency; Regulation;
    All these keywords.

    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis

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