Credit default swaps and firms' financing policies

Abstract

This paper examines the impact of credit default swaps (CDS) on firms' financing and trade credit policies. Our results indicate firms with CDS trading on their debt increase their equity issuances. Further, firms with CDS trading on their debt and high levels of long-term debt issuances decrease their debt financing. Total and idiosyncratic risks are also higher for firms with CDS trading on their debt. These firms pay their suppliers and collect from their customers quicker. Thus, the impacts of the CDS market are not limited to the borrowing firms but also affect economically connected firms.

Do Noisy Fair Values of Derivatives Distort Bank Capital Adequacy Ratios?

“…However, during the crisis, massive write-downs resulted from the use of credit derivatives, because the default rates on subprime mortgages were soaring. Fuller, et al (2018) even find that firms with CDSs trading on their debt have greater equity issuance with higher risk.…”

Being Naked - et Quo hinc?: Developing a ‘Skin-in-the-Game’ Solution for Credit Default Swaps

“…By 2007, CDSs triggered the effects of defaults and facilitated the GFC (Fostel and Geanakoplos 2012). CDSs ease creditors to hedge borrower credit risk (Fuller et al 2018). Moreover, CDSs weakens creditors' incentive to monitor borrowers (Kim et al 2018) and hence can result in excessive risk taking (Baluch et al 2011).…”

“…This paper argues that the post-GFC literature focussing on CDSs fails to address the moral hazard concern inherently embedded in CDSs. As Fuller et al (2018) and Kim et al (2018) identify, CDSs deteriorate a creditor's incentive to monitor borrowers, since the risk can be shifted to a third party. Even though the post-GFC literature attempts to regulate CDSs in numerous means, the literature fails in addressing the core concern associated with CDSs, the issue of the moral hazard.…”