Does the Tail Wag the Dog?: The Effect of Credit Default Swaps on Credit Risk

Subrahmanyam, Marti G.; Tang, Dragon Yongjun; Wang, Sarah Qian

doi:10.1093/rfs/hhu038

Cited by 225 publications

(122 citation statements)

References 59 publications

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“…However, the necessary sample size is rather large. This is consistent with the findings of Subrahmanyam, Tang, and Wang (2012), who use a large sample to show that CDS contracts increase the likelihood of bankruptcy. However, it is difficult to link their findings to a particular channel through which CDSs affect bankruptcy.…”

Section: Simulation Study and Discussionsupporting

confidence: 90%

“…Finally, in direct tests of the empty creditor hypothesis, there is mixed evidence in the literature. Bedendo, Cathcart, and El-Jahel (2011) find no significant effect of CDS contracts on the probability of bankruptcy, while Subrahmanyam, Tang, and Wang (2012) find a positive effect. In a simulation study, I am able to reconcile these conflicting results.…”

Section: Jel Kódok: G33 G34mentioning

confidence: 88%

“…This explains why it is more likely to identify the empty creditor problem in distressed exchange offers, even in a small sample. It also explains why Subrahmanyam, Tang, and Wang (2012), who use a larger sample than Bedendo, Cathcart, and El-Jahel (2011), find that CDS contracts have a significant effect on the probability of bankruptcy. Also, Subrahmanyam, Tang, and Wang (2012) argue that the higher bankruptcy risk is due to the empty creditor problem.…”

Section: Jel Kódok: G33 G34mentioning

confidence: 97%

“…It also explains why Subrahmanyam, Tang, and Wang (2012), who use a larger sample than Bedendo, Cathcart, and El-Jahel (2011), find that CDS contracts have a significant effect on the probability of bankruptcy. Also, Subrahmanyam, Tang, and Wang (2012) argue that the higher bankruptcy risk is due to the empty creditor problem. While it is difficult to identify the channel through which CDSs lead to bankruptcy, the present paper suggests that it might be via the failure of out-of-court restructurings.…”

Section: Jel Kódok: G33 G34mentioning

confidence: 97%

“…Therefore, the CDS dummy seems to be a useful proxy variable for the CDS insurance ratio. This variable is also used by Saretto and Tookes (2012), Bedendo, Cathcart, andEl-Jahel (2011), andSubrahmanyam, Tang, andWang (2012).…”

Section: Empirical Frameworkmentioning

confidence: 99%

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Do Empty Creditors Matter? Evidence from Distressed Exchange Offers

Danis

2017

Management Science

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may Do Empty Creditors Matter?Evidence from Distressed Exchange Offers András DanisAbstract I examine the effect of credit default swaps (CDSs) on the restructuring of distressed firms.Theoretically, I show that if bondholders are insured with CDSs, the participation rate in a restructuring decreases. Using a sample of distressed exchange offers, I estimate that the participation rate is 29% lower if the firm has CDSs traded on its debt, compared to an unconditional mean of 54%. I use the introduction of the Big Bang protocol as a natural experiment. The results suggest that firms with CDSs find it difficult to reduce debt out-ofcourt, which is inefficient because it increases the likelihood of future bankruptcy.Keywords: credit default swaps, CDS, empty creditor, restructuring, bankruptcy Abstract I examine the effect of credit default swaps (CDSs) on the restructuring of distressed firms. Theoretically, I show that if bondholders are insured with CDSs, the participation rate in a restructuring decreases. Using a sample of distressed exchange offers, I estimate that the participation rate is 29% lower if the firm has CDSs traded on its debt, compared to an unconditional mean of 54%. I use the introduction of the Big Bang protocol as a natural experiment. The results suggest that firms with CDSs find it difficult to reduce debt out-of-court, which is inefficient because it increases the likelihood of future bankruptcy. For example, if the CDS insures the face value of debt, creditors will reject any offers by a financially distressed company for payments below face value. Thus, if a firm's lenders are empty creditors, i.e. insured with CDSs, the firm cannot easily reduce its debt in an out-ofcourt restructuring prior to bankruptcy. I present evidence consistent with this hypothesis.Credit default swaps pose a problem because failure to renegotiate debt privately can increase the likelihood of future bankruptcy, which can incur deadweight losses. In addition, the existence of CDSs might also be relevant for firms that are not currently distressed. Their investment and financing decisions today can depend on the possibility that debt may be difficult to renegotiate if the firm encounters financial distress. Also, the question addressed in this paper relates to the broader topic of the net welfare effects of CDSs in the economy.Bolton and Oehmke (2011) argue that CDS contracts introduce certain inefficiencies, but that t...

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Section: Simulation Study and Discussionsupporting

confidence: 90%

Section: Jel Kódok: G33 G34mentioning

confidence: 88%

Section: Jel Kódok: G33 G34mentioning

confidence: 97%

Section: Jel Kódok: G33 G34mentioning

confidence: 97%

Section: Empirical Frameworkmentioning

confidence: 99%

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Do Empty Creditors Matter? Evidence from Distressed Exchange Offers

Danis

2017

Management Science

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References

2019

Corporate Financial Distress, Restructuring, and Bankruptcy

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Central clearing and CDS market quality

Silva

Vieira

2018

Journal of Futures Markets

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This paper contributes to the literature on the impact of central clearing on financial market quality. Focusing on the CDS market, a difference‐in‐differences analysis is performed to identify effects of voluntary central clearing of contracts on ICECC and ICECE. Patterns of market quality proxies are compared before and after central clearing initiation. We conclude that central clearing improves liquidity, price informativeness and precision, and also the integration of the CDS and stock markets. Results are inconclusive for the impact on CDS price volatility.

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Does the Tail Wag the Dog?: The Effect of Credit Default Swaps on Credit Risk

Cited by 225 publications

References 59 publications

Do Empty Creditors Matter? Evidence from Distressed Exchange Offers

Do Empty Creditors Matter? Evidence from Distressed Exchange Offers

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Central clearing and CDS market quality

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