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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/31421
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| Title: | Does the Tail Wag the Dog? The Effect of Credit Default Swaps on Credit Risk |
| Authors: | Subrahmanyam, Marti G.
Tang, Dragon Yongjun
Wang, Sarah Qian |
| Issue Date: | 9-Jan-2012 |
| Series/Report no.: | FIN-11-046 |
| Abstract: | Concerns have been raised, especially since the global financial crisis,
about whether trading in credit default swaps (CDS) increases the credit
risk of the reference entities. This study examines this issue by
quantifying the impact of CDS trading on the credit risk of firms. We
use a unique, comprehensive sample covering 901 CDS introductions on
North American corporate issuers between June 1997 and April 2009 to
address this question. We present evidence that the probability of a
credit downgrade and of bankruptcy both increase after the inception of
CDS trading. The effect is robust to controlling for the endogeneity of
CDS introduction, i.e., the possibility that firms selected for CDS
trading are more likely to suffer a subsequent deterioration in
creditworthiness. We show that the CDS-protected lenders’
reluctance to restructure is the most likely cause of the increase in
credit risk. We present evidence that firms with relatively large
amounts of CDS contracts outstanding, and those with “No
Restructuring” contracts, are more likely to be adversely affected
by CDS trading. We also document that CDS trading increases the level of
participation of bank lenders to the firm. Our findings are broadly
consistent with the predictions of the “empty creditor”
model of Bolton and Oehmke (2011). |
| URI: | http://hdl.handle.net/2451/31421 |
| Appears in Collections: | Finance Working Papers
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