Credit Default Swaps: Has the GFC Influenced Perceptions of Their Utility for Banks?

Abstract

Credit Default Swaps (CDSs) are considered as one of the most versatile financial innovations of the 21st century. Since its inception, the credit derivatives market has grown to a peak of $64 trillion in 2008 in terms of gross notional values (Cont, ). However, after the onset of the GFC, this market has decreased to a large extent. While there is evidence that promotes the risk reduction properties of CDSs, there is a growing body of research post GFC that identifies destabilising effects of these instruments. In this paper, I review the relevant scholarly literature and provide evidence of how the views on CDSs have changed post GFC due a deeper investigation of issues such as systemic risk, regulatory arbitrage, information asymmetry and risk‐taking, among others, in the banking industry. This paper provides a survey of the literature of views ‘for’ and ‘against’ the use of CDSs during pre and post GFC periods and finally concludes that in comparison to the pre GFC period, post GFC there is a significant increase in the literature that highlights the detrimental nature of CDSs.

Why do banks use credit default swaps (CDS)? A systematic review

“…CDS have been the subject of several researches that reviewed the findings of impact studies. Many review studies, for example, focused on the role of CDS during pre‐ and post‐global financial period and provided its thorough understanding (Augustin et al., 2014, 2016; Culp et al., 2016; Dias, 2016; Lando, 2020; Stulz, 2010). Another strand of literature emphasized the nuances of CDS contracts structure using accounting and insurance studies as a base (Griffin, 2014; Jarrow, 2011).…”

Credit Cycles, Securitization, and Credit Default Swaps

“…Extensive surveys are Augustin, Subrahmanyam, Tang, and Wang (2014) and Dias (2015). Anderson (2010) points out that although CDS may give social benefits in risk sharing and price discovery, these benefits may be undermined if the contract is prone to manipulation or if does not deal with counterparty risk.…”