Credit Default Swaps, Firm Financing and the Economy

Campello, Murillo; Matta, Rafael

doi:10.2139/ssrn.1770066

Cited by 33 publications

(21 citation statements)

References 28 publications

Supporting

Mentioning

Contrasting

Order By: Relevance

“…The foregoing assumption distinguishes the present paper from Bolton and Oehmke (2011) and Campello and Matta (2012). These very insightful papers analyze the e¤ect of CDS availability on renegotiation in an incomplete contracting model of debt with strategic default.…”

Section: Introductionmentioning

confidence: 90%

“…Given the inference function eq , the hedge fund's trading pro…ts are zero regardless of the noise realization unless x y x + and x > x, and thus expected pro…ts for such trades are negative given positive trading costs. 5 Moreover, by construction (see proof of Lemma 1), eq ensures that for each trade (x; y) such that x < x y x + , there is a corresponding trade (x; y ) 2 ! that yields equal expected pro…ts unless expected pro…ts for both trades are negative.…”

Section: Propositionmentioning

confidence: 99%

See 1 more Smart Citation

Derivatives Trading and Negative Voting

Spamann

2012

SSRN Journal

View full text Add to dashboard Cite

This paper exposits a model of parallel trading of corporate securities (shares, bonds) and derivatives in which a large trader can sometimes pro…tably acquire securities with their corporate control rights for the sole purpose of reducing the corporation's value and gaining on a net short position created through o¤-setting derivatives. At other times, the large trader profitably takes a net long position. The large trader requires no private information beyond its own trades. The problem is most likely to manifest when derivatives trade on an exchange and transactions give blocking powers to small minorities, particularly out-of-bankruptcy restructurings and freezeouts. JEL: G34, K22.Assistant professor, Harvard Law School. hspamann@law.harvard.edu. For comments and helpful discussions, I thank

show abstract

Section: Introductionmentioning

confidence: 90%

Section: Propositionmentioning

confidence: 99%

Derivatives Trading and Negative Voting

Spamann

2012

SSRN Journal

View full text Add to dashboard Cite

show abstract

“…Using the facts emphasized the previous remark in formula (5) leads to the following more simple expressions of the default probability: Lemma 4.3. The F t -conditional default probability for t ≤ T , associated with the switching time θ ≥ t is given by:…”

Section: Endogenous Trading In Credit Default Swapsmentioning

confidence: 97%

Endogenous trading in credit default swaps

Chesney

Coculescu

Gökay

2015

Decisions Econ Finan

View full text Add to dashboard Cite

We introduce a real options model in order to quantify the moral hazard impact of credit default swap (CDS) positions on the corporate default probabilities. Moral hazard is widely addressed in the insurance literature, where the insured agent may become less cautious about preventing the risk from occurring. Importantly, with CDS the moral hazard problem may be magnified since one can buy multiple protections for the same bond. To illustrate this issue, we consider a firm with the possibility of switching from an investment to another one. An investor can influence the strategic decisions of the firm and can also trade CDS written on the firm. We analyze how the decisions of the investor influence the firm value when he is allowed to trade credit default contracts on the firm's debt. Our model involves a time-dependent optimal stopping problem, which we study analytically and numerically, using the Longstaff-Schwartz algorithm. We identify the situations where the investor exercises the switching option with a loss, and we measure the impact on the firm's value and firm's default probability. Contrary to the common intuition, the investors' optimal behavior does not systematically consist in buying CDSs and increase the default probabilities. Instead, large indifference zones exist, where no arbitrage profits can be realized. As the number of the CDSs in the position increases to exceed several times the level of a complete insurance, we enter in the zone where arbitrage profits can be made. These are obtained by implementing very aggressive strategies (i.e., increasing substantially the default probability by producing losses to the firm). The profits increase sharply as we exit the indifference zone. Abstract. We introduce a real options model in order to quantify the moral hazard impact of credit default swap (CDS) positions on the corporate default probabilities. Moral hazard is widely addressed in the insurance literature, where the insured agent may become less cautious about preventing the risk from occurring. Importantly, with CDS the moral hazard problem may be magnified since one can buy multiple protections for the same bond.To illustrate this issue, we consider a firm with the possibility of switching from an investment to another one. An investor can influence the strategic decisions of the firm and can also trade CDS written on the firm. We analyze how the decisions of the investor influence the firm value when he is allowed to trade credit default contracts on the firm's debt. Our model involves a time-dependent optimal stopping problem, which we study analytically and numerically -using the Longstaff-Schwartz algorithm. We identify the situations where the investor exercises the switching option with a loss and we measure the impact on the firm's value and firm's default probability. Contrary to the common intuition, the investors optimal behavior does not systematically consist in buying CDSs and increase the default probabilities. Instead, large indifference zones exists, where no ar...

show abstract

“…Campello and Matta (2013) predict that the empty creditor problem is indeed procyclical, based on a static three-period investment model.…”

Section: On This Topicmentioning

confidence: 99%

Credit Default Swaps: A Survey

et al. 2014

View full text Add to dashboard Cite

Credit default swaps (CDS) have been growing in importance in the global financial markets. However, their role has been hotly debated, in industry and academia, particularly after the credit crisis of 2008-2009 and the European sovereign crisis of 2010-2012. We review the extant literature on CDS that has accumulated over the past two decades. We divide our survey into seven topics after providing a broad overview in the introduction. The second section traces the historical development of CDS markets and provides an introduction to CDS contract definitions and conventions. The third section discusses the pricing of CDS, from the perspective of no-arbitrage principles as well as from that of structural and reduced-form credit risk models. It also summarizes the literature on the determinants of CDS spreads, with a focus on the role of fundamental credit risk factors, liquidity and counterparty risk. The fourth section discusses how the development of the CDS market has affected the characteristics of the related bond and equity markets, with an emphasis on the closely related concepts of market efficiency, price discovery, information flow and liquidity. Attention is also paid to the CDS-bond basis, the wedge between the pricing of the CDS and its reference bond, and the mispricing between the CDS and the equity market, which leads to a discussion on capital structure arbitrage. The fifth section examines the effect of CDS trading on firms' credit and bankruptcy risk, and how it affects corporate financial policy, including bond issuance, capital structure, liquidity management, and both external and internal corporate governance. The sixth section summarizes the literature that takes into account how CDS may impact the incentives of the various agents in the economy and the associated impact on the pricing of the contracts. In particular, we examine how CDS may alter the debtor-creditor relationship. Section seven reviews the growing literature on sovereign CDS and highlights the major conceptual and contractual differences between the sovereign and corporate CDS markets. In section eight, we discuss CDS indices, especially the role of synthetic CDS index products backed by residential mortgage-backed securities during the financial crisis. We close with our suggestions for promising future research directions on CDS contracts and markets.

show abstract

Credit Default Swaps, Firm Financing and the Economy

Abstract: We develop a model in which investment risk drives the demand for CDS insurance. We show that CDS overinsurance (insurance in excess of renegotiation proceeds) is procycli-

Cited by 33 publications

References 28 publications

Derivatives Trading and Negative Voting

Derivatives Trading and Negative Voting

Endogenous trading in credit default swaps

Credit Default Swaps: A Survey

Contact Info

Product

Resources

About