Credit Default Swaps, Strategic Default, and the Cost of Corporate Debt

Kim, Gi H.

doi:10.2139/ssrn.2230394

Cited by 8 publications

(8 citation statements)

References 38 publications

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“…Ashcraft & Santos (2009) suggest that the initiation of CDS trading can have a screening benefit, as the effect of CDS initiation depends on the borrower's credit quality: It reduces borrowing costs for creditworthy borrowers and increases them for risky and informationally opaque firms. Kim (2013), however, argues that it is those firms with high strategic default incentives that benefit from a relatively larger reduction in their corporate bond spreads, and the evidence in Asia provided by Shim & Zhu (2014) points toward a more modest discount in yield spreads at issuance owing to CDS trading initiation.…”

Section: Impact Of Cds On Asset Prices Liquidity and Efficiencymentioning

confidence: 99%

Credit Default Swaps: Past, Present, and Future

Augustin

Subrahmanyam

Tang

et al. 2016

Annu. Rev. Financ. Econ.

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Credit default swaps (CDS) have grown to be a multi-trillion-dollar, globally important market. The academic literature on CDS has developed in parallel with the market practices, public debates, and regulatory initiatives in this market. We selectively review the extant literature, identify remaining gaps, and suggest directions for future research. We present a narrative including the following four aspects. First, we discuss the benefits and costs of CDS, emphasizing the need for more research in order to better understand the welfare implications. Second, we provide an overview of the postcrisis market structure and the new regulatory framework for CDS. Third, we place CDS in the intersection of law and finance, focusing on agency conflicts and financial intermediation. Last, we examine the role of CDS in international finance, especially during and after the recent sovereign credit crises. 10.1

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Section: Impact Of Cds On Asset Prices Liquidity and Efficiencymentioning

confidence: 99%

Credit Default Swaps: Past, Present, and Future

Augustin

Subrahmanyam

Tang

et al. 2016

Annu. Rev. Financ. Econ.

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“…However, what this argument does not consider is that taking a long position on credit risk by selling a CDS allows an investor to take more leverage than buying the bond on margin because the initial margin requirements are different. 12 For example, according to the Financial Industry Regulator Authority (FINRA), the initial margin requirement for selling a 5yr CDS with a spread over LIBOR less than 100 bps is 4% of the notional amount of the CDS contract. Conversely, the regulatory minimum to purchase an investment grade bond on margin-assuming that the spread over LIBOR for said bond is also less than 100 bps-is 10% of the market value of the purchase.…”

Section: Investor Maximization Problemmentioning

confidence: 99%

“…The more optimistic investor, h 1 , is indifferent between selling a CDS on firm-B debt and buying firm-G bonds in (12). The more pessimistic investor, h 2 , is indifferent between buying a CDS on firm-B debt and buying firm-G bonds in (13).…”

Section: Borrowing Costs and Spillovers Revisitedmentioning

confidence: 99%

“…Current empirical studies on the effect of CDSs on default risk stem from the predictions of the empty creditor problem which require the effects to operate through hedging credit risk (see Subrahmanyam, Wang, and Tang (2014); Kim (2013); and Shan, Tang, and Winton (2015)). However, these studies cannot distinguish between covered and naked CDS positions.…”

Section: Introductionmentioning

confidence: 99%

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Credit Default Swaps in General Equilibrium: Spillovers, Credit Spreads, and Endogenous Default

Darst

Refayet

2016

FEDS

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This paper highlights two new effects of credit default swap markets (CDS) in a general equilibrium setting. First, when firms' cash flows are correlated, CDSs impact the cost of capital-credit spreads-and investment for all firms, even those that are not CDS reference entities. Second, when firms internalize the credit spread changes, the incentive to issue safe rather than risky bonds is fundamentally altered. Issuing safe debt requires a transfer of profits from good states to bad states to ensure full repayment. Alternatively, issuing risky bonds maximizes profits in good states at the expense of default in bad states.Profits fall when credit spreads increase, which raises the opportunity cost of issuing risky debt compared to issuing safe debt. Symmetrically, lower credit spreads reduce the opportunity cost of issuing risky debt relative to safe debt.CDSs affect the credit spread at which firms issue risky debt, and ultimately the opportunity cost of issuing defaultable bonds even when underlying firm fundamentals remain unchanged. Hedging (Speculating on) credit risk lowers (raises) credit spreads and enlarges (reduces) the parameter region over which firms choose to issue risky debt.2

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“…This reveals a new aspect that the CDS market can impact on the cash market and adds to the growing literature on the impact of CDS on the real economy. For example, Bolton and Oehmke (2011) show the implications of the empty creditor problem when debtors have access to CDS contracts, and Kim (2013) provides some empirical evidence on the ex-ante impact of empty creditors on corporate debt contracting. Saretto and Tookes (2013) show that firms have lower financing costs and can lengthen debt maturity when there are available CDS contracts.…”

Section: Introductionmentioning

confidence: 99%