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Does the Tail Wag the Dog? The Effect of Credit Default Swaps on Credit Risk

In: Development in India

Author

Listed:
  • Marti G. Subrahmanyam

    (New York University)

  • Dragon Yongjun Tang

    (University of Hong Kong)

  • Sarah Qian Wang

    (University of Warwick)

Abstract

We use credit default swaps (CDS) trading data to demonstrate that the credit risk of reference firms, reflected in rating downgrades and bankruptcies, increases significantly upon the inception of CDS trading, a finding that is robust after controlling for the endogeneity of CDS trading. Additionally, distressed firms are more likely to file for bankruptcy if they are linked to CDS trading. Furthermore, firms with more “no restructuring” contracts than other types of CDS contracts (i.e., contracts that include restructuring) are more adversely affected by CDS trading, and the number of creditors increases after CDS trading begins, exacerbating creditor coordination failure in the resolution of financial distress.

Suggested Citation

  • Marti G. Subrahmanyam & Dragon Yongjun Tang & Sarah Qian Wang, 2016. "Does the Tail Wag the Dog? The Effect of Credit Default Swaps on Credit Risk," India Studies in Business and Economics, in: S. Mahendra Dev & P.G. Babu (ed.), Development in India, edition 127, chapter 0, pages 199-236, Springer.
    • Handle: RePEc:spr:isbchp:978-81-322-2541-6_11
    DOI: 10.1007/978-81-322-2541-6_11
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