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 ABSTRACTConcerns 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).

How should we think about the determination of interest rates in China after interest rate liberalization? Would effective deposit rates, lending rates, and bond yields move higher or lower? We argue that interest rates in a liberalized environment would need to be anchored by monetary policy. To achieve price and output (or employment) stabilization, the policy rate should be set close to China's equilibrium or natural rate. We sketch three preliminary approaches to estimation of the natural rate. Based on this analysis, we argue that interest rates on large deposits and short-term money-market rates would likely move higher following liberalization. The effect on effective lending rates is somewhat ambiguous, as the contestability of the banking sector and the competition from the bond markets are likely to increase. We leave the determination of the curvature of the yield curve to future research.

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