Credit Default Swaps Around the World

Abstract

We analyze the impact of the introduction of credit default swaps (CDS) on real decision making within the firm and the influence of firms’ local economic and legal environments on that impact. We extend the model of Bolton and Oehmke (2011) to take into account uncertainty about whether the actions taken by the reference entity will trigger credit events for CDS obligations. We test the predictions of our model in a sample of more than 56,000 firms across 51 countries over the period 2001–2015 and find substantial evidence that the introduction of CDS affects real decisions. Importantly, we find that the legal and market environments in which reference entities operate have an influence on the impact of CDS. The effect of CDS is larger in environments where uncertainty regarding CDS obligations is reduced and where weak property rights are mitigated by CDS. Our results shed light on the incomplete nature of CDS contracts in international capital markets, which is related to significant legal uncertainty surrounding the interpretation of underlying credit events.