Can Contract of Credit Default Swaps Mitigate Moral Hazard?

Abstract

In this paper, we discuss how the moral hazard of credit derivatives make financial crisis more serious, and contract of credit default swap (CDS) to inspect the function of the financial instruments and to control the moral hazard. The research shows that CDS can improve reallocation of the credit risk and the bank’s return, and enlarge investment channels. However, it would cut back the bank’s efforts of monitoring credit assets which would accumulate and increase credit risks. By the partial protection mechanism, we build a contract which could effectively control the moral hazard.