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Are credit default swaps associated with higher corporate defaults?

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  • Stavros Peristiani
  • Vanessa Savino

Abstract

Are companies with traded credit default swap (CDS) positions on their debt more likely to default? Using a proportional hazard model of bankruptcy and Merton?s contingent claims approach, we estimate the probability of default for U.S. nonfinancial firms. Our analysis does not generally find a persistent link between CDS and default over the entire period 2001-08, but does reveal a higher probability of default for firms with CDS over the last few years of that period. Further, we find that firms trading in the CDS market exhibited a higher Moody?s KMV expected default frequency during 2004-08. These findings are consistent with those of Henry Hu and Bernard Black, who argue that agency conflicts between hedged creditors and debtors would increase the likelihood of corporate default. In addition, our paper highlights other explanations for the higher defaults of CDS firms. Consistent with fire-sale spiral theories, we find a positive link between institutional ownership exposure and corporate distress, with CDS firms facing stronger selling pressures during the recent financial turmoil.

Suggested Citation

  • Stavros Peristiani & Vanessa Savino, 2011. "Are credit default swaps associated with higher corporate defaults?," Staff Reports 494, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:494
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    References listed on IDEAS

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    Cited by:

    1. Söhnke M Bartram & Jennifer Conrad & Jongsub Lee & Marti G Subrahmanyam, 2022. "Credit Default Swaps around the World," The Review of Financial Studies, Society for Financial Studies, vol. 35(5), pages 2464-2524.
    2. Clark, Brian & Donato, James & Francis, Bill B & Shohfi, Thomas D, 2023. "Bank loan renegotiation and credit default swaps," Journal of Banking & Finance, Elsevier, vol. 151(C).
    3. Bolton, Patrick & Oehmke, Martin, 2013. "Strategic conduct in credit derivative markets," International Journal of Industrial Organization, Elsevier, vol. 31(5), pages 652-658.

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    Keywords

    Swaps (Finance); Credit derivatives; Corporations - Finance; Default (Finance); Bankruptcy;
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