Pitfalls and perils of financial innovation: The use of CDS by corporate bond funds

Adam, Tim; Guettler, Andre

doi:10.1016/j.jbankfin.2015.02.019

Cited by 34 publications

(12 citation statements)

References 34 publications

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“…About

62 %

of the positions involve a sale of CDS, indicating that, on the whole, mutual funds use CDS to seek additional credit exposure. This general pattern is consistent with those documented in Adam and Guettler (2015) and Aragon, Li, and Qian (2015).…”

Section: Institutional Background and Sample Overviewsupporting

confidence: 91%

“…This study contributes to the burgeoning literature on CDS from the perspective of end users rather than that of issuers and transactions, which most of the existing empirical research on CDS focus on (see the survey by Augustin et al (2014), and the recent paper by Siriwardane (2019)). Closely related to our study are two papers relating CDS and mutual funds by Adam and Guettler (2015) and Aragon, Li, and Qian (2015). While the data and samples of these papers have some overlap with ours, the research questions are distinct.…”

mentioning

confidence: 66%

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Mutual Fund Holdings of Credit Default Swaps: Liquidity, Yield, and Risk

Jiang¹,

Ou²,

Zhu³

2020

The Journal of Finance

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This study analyzes the motivations for and consequences of funds' credit default swap (CDS) investments using mutual funds' quarterly holdings from pre‐ to postfinancial crisis. Funds invest in CDS when facing unpredictable liquidity needs. Funds sell more in reference entities when the CDS is liquid relative to the underlying bonds and buy more when the CDS‐bond basis is more negative. To enhance yield, funds engage in negative basis trading and sell CDS with the highest spreads within rating categories, and with spreads higher than those of their bond portfolios. Funds with superior portfolio returns also demonstrate more skill in CDS trading.

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“…About

62 %

Section: Institutional Background and Sample Overviewsupporting

confidence: 91%

mentioning

confidence: 66%

Mutual Fund Holdings of Credit Default Swaps: Liquidity, Yield, and Risk

Jiang¹,

Ou²,

Zhu³

2020

The Journal of Finance

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“…This assumption is indeed realistic: Major institutional investors of corporate bonds such as banks and insurance companies regularly report that credit risk hedging accounts for a significant portion of their activities in CDSs (see the Quarterly Report on Bank Derivatives Activities and the Capital Markets Special Report on the Insurance Industry Derivatives Exposure —various issues). In addition, Danis () and Adam and Guettler () provide evidence that fixed income mutual funds routinely purchase protection through CDSs to hedge the credit risk associated with the underlying bond portfolios.…”

Section: Empirical Findingsmentioning

confidence: 99%

Distressed Debt Restructuring in the Presence of Credit Default Swaps

Bedendo¹,

Cathcart²,

El-Jahel³

2016

Journal of Money, Credit and Banking

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The availability of credit insurance via credit default swaps has been closely associated with the emergence of empty creditors. We empirically investigate this issue by looking at the debt restructurings (distressed exchanges and bankruptcy filings) of rated, nonfinancial U.S. companies over the period January 2007–June 2011. Using different proxies for the existence of insured creditors, we do not find evidence that the access to credit insurance favors bankruptcy over a debt workout. However, we document higher recovery prices following a distressed exchange in firms where empty creditors are more likely to emerge.

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“…71 Regulatory arbitrage, if left unattended to by regulators, could in time increase systemic risks. 72 This is because relatively un or under-regulated markets tend to create volumes of credit that may not be stringently under-written or generally well-controlled. Increased levels of debt across households and corporations could raise the risks of systemic fragility in the financial system.…”

Section: Regulation and Innovationmentioning

confidence: 99%

A Rational Regulatory Strategy for Governing Financial Innovation

Chiu¹

2017

Eur. j. risk regul.

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Modern financial regulation has predominantly been economically-driven,1 progressing from addressing market failures to making markets more competitive and work better.2 The UK Financial Conduct Authority is expressly mandated to pursue regulatory objectives that maintain market integrity and protect consumers (addressing market failures) and to promote competition (making markets work better).3 Both the FCA and its sister regulator, the Prudential Regulation Authority (for banks), have recently adopted innovative regulatory initiatives to promote technologically-driven innovation, aimed at making markets work better. These initiatives are also a response to the recent explosion of technologically-led financial innovation outside of the regulatory perimeter.In promoting financial innovation, we argue that the regulators have insufficiently focused on the need to govern financial innovation more generally. Although this concern may seem premature, the regulatory innovations are increasingly extending the perimeter for regulatory oversight of financial innovations. As the regulatory innovations have the potential to develop into more mature regulatory frameworks for governing financial innovation, we argue that regulators should manage the risks of their current approach and develop a regulatory strategy framework for balancing regulatory objectives and developing regulatory policy. We propose a framework anchored in rationality, consistency and accountability in governing financial innovation.

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Pitfalls and perils of financial innovation: The use of CDS by corporate bond funds

Cited by 34 publications

References 34 publications

Mutual Fund Holdings of Credit Default Swaps: Liquidity, Yield, and Risk

Mutual Fund Holdings of Credit Default Swaps: Liquidity, Yield, and Risk

Distressed Debt Restructuring in the Presence of Credit Default Swaps

A Rational Regulatory Strategy for Governing Financial Innovation

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