Role Of Credit Default Swaps Research Articles

Financialization, confidence, and sovereign debt markets: The role of Credit Default Swaps in the Southern European debt crisis

This article analyzes the state–market nexus by examining the role played by sovereign credit default swap (CDS) derivative markets in the southern European debt crisis of 2010–2014. This nexus is conceived of as being part of a larger process of state financialization and, more specifically, of sovereign debt management. This article shows that the southern European debt crisis was triggered by the deterioration of fundamental macroeconomic variables—not self-fulfilling dynamics driven by speculation. Moreover, the financialization of public debt markets may generate opportunities for governments to manage their public financing needs, which illustrates the complex nexus between markets and governments.

The role of credit default swaps in determining corporate payout policy

AbstractWe examine how the introduction of credit default swap (CDS) trading on the debt of individual firms affects corporate payout policy. We find that firms increase payouts to shareholders after the introduction of CDS trading on their debt. This suggests that CDS‐referenced firms are more likely to be affected by decreased creditor monitoring than by tougher CDS‐insured creditors when determining total payout amount. Moreover, the increase in payouts after CDS introduction is more pronounced in firms with smaller institutional ownership and greater bank debt dependency. Finally, we show that CDS‐referenced firms tend to prefer stock repurchases that have a financial flexibility advantage over dividends to protect against the potential threat of tougher CDS‐insured creditors.

How do sovereign risk, equity and foreign exchange derivatives markets interact?

To examine the propagation of shocks across markets, this paper examines the dynamic connections between three distinct markets: the credit default swaps (CDS), equities, and cross-currency basis swaps (CCBS) of four major individual economies: the Eurozone, the UK, Australia, and Japan. We use CDS spreads, CCBS spreads, and stock market returns to capture sovereign credit risk, dollar funding pressure, and stock market performance, respectively. Our results show that a feedback mechanism connects these markets. Higher CDS spreads induce wider CCBS spreads and declines in stock market returns; positive shocks to CCBS spreads lessen CDS spreads and enhance stock market returns; and positive shocks to the stock market lead to lower CDS spreads and tighter CCBS spreads. These findings are supported by Granger causality analysis and are robust across subperiods and empirical specifications. Underpinning the feedback mechanism is the role of CDS as an indicator of potential default on obligations.

Sovereign Risk, Cross-Currency Basis and Equity Markets: A Cross-Market Dynamic Interaction

To explore the propagation of shocks across markets, this paper examines the dynamic connections between three distinct markets: credit default swaps (CDS), equities, and cross-currency basis swaps (CCBS) of four major individual economies: Eurozone, UK, Australia, and Japan. We use CDS spreads, CCBS spreads and stock market returns to capture sovereign credit risk, dollar funding liquidity and stock market performance, respectively. Our results show there is a feedback mechanism connecting these markets, for most of these economies. We document that higher CDS spreads induce wider CCBS spreads and declines in stock market returns. We equally show that positive shocks to CCBS spreads lessen CDS spreads and enhance stock market returns. Finally, we show that positive shocks to the stock market are associated with lower CDS spreads and tighter CCBS spreads. These findings are supported by Granger-causality analysis and are robust across subperiods and empirical specifications. Underpinning the feedback mechanism is the role of CDS as an indicator of potential default on obligations in the financial markets.

Credit derivatives and stock return synchronicity

The role of credit default swaps (CDS) in the 2008 financial crisis has been widely debated among regulators, investors, and researchers. While CDS were blamed for destabilizing the financial system, they remain effective tools for hedging credit risk, especially for major banks, and produce positive informational externalities to market participants. This paper examines whether the introduction of CDS enhances the amount of firm-specific information impounded in stock prices. We use stock return synchronicity to measure the amount of firm-specific information reflected in stock prices, with more firm-specific information being associated with a lower level of synchronicity. We find that a firm’s stock return synchronicity decreases after the commencement of CDS trading. This finding is robust to different model specifications, synchronicity measures, and endogeneity controlling methodologies. Furthermore, the decrease in stock return synchronicity is more pronounced for CDS firms with higher credit risk. Overall, our evidence supports the positive role of CDS in improving informativeness of stock prices.

Credit Derivatives and Analyst Behavior

ABSTRACT This paper presents a comprehensive analysis of the role of credit default swaps (CDS) in information production surrounding earnings announcements. First, we demonstrate that the strength of CDS price discovery prior to earnings announcements is related to the presence of private information and the illiquidity of the underlying corporate bonds, consistent with the CDS market being a preferred venue for informed trading. Next, we ask how the information revealed through CDS trading influences the output of equity and credit rating analysts. We find that post-CDS trading, the dispersion and error of earnings per share forecasts are generally reduced, and downgrades by both types of analysts become more frequent and more timely before large negative earnings surprises, suggesting that the CDS market conveys information valuable to financial analysts.

Credit Derivatives and Earnings Announcements

This paper presents a comprehensive analysis of the role of credit default swaps (CDS) in information production surrounding earnings announcements. First, we demonstrate that the strength of CDS price discovery prior to earnings announcements is related to the presence of private information and the illiquidity of the underlying corporate bonds, consistent with the CDS market being a preferred venue for informed trading. Next, we ask how the information revealed through CDS trading influences the output of equity and credit rating analysts. We find that post-CDS trading, the dispersion and error of earnings-per-share forecasts are generally reduced, and downgrades by both types of analysts become more frequent and more timely before large negative earnings surprises, suggesting that the CDS market conveys information valuable to financial analysts.

ANALYSIS OF LITHUANIAN CREDIT DEFAULT SWAPS

This paper studies international sovereign Credit Default Swaps (CDS) market focusing attention to the CDS of Central and East Europe. The main purpose of the study was to perform detail analysis of Lithuanian CDS in the global capital market. We compared the CDS markets of other countries and found some commonalities between them. We study the credit curve produced by CDS and volatility of CDS. A great attention is paid to investigate the relationship of CDS and the government bond market. Analysis of finding a leading role of CDS and the bond markets in the price discovering process is made. A leading market for different periods is found by using the Vector Error Correction model. Our main finding is that during the volatile period price discovery takes place in the bond market and in the calm period price discovery is observed in the CDS market. Disclosed relationship between CDS spreads and Eurobonds yield risk premium gives an additional decision making tool for sovereign debt managers.

Do Credit Default Swaps Affect Lending Practices? Evidence from Syndicate Structures and the London Whale Incident

This paper tests the monitoring concentration hypothesis that loan participants can transfer monitoring incentives back to lead arrangers by purchasing credit default swaps (CDSs) from lead arrangers with the capacity to sell such contracts. Monitoring concentration appears to play a significant role in reducing lead arrangers’ loan allocation, expanding syndicate size resulting in larger loans for borrowers, and increasing the usage of covenants. Other loan CDS dealers participating in the same syndicates dilutes the role of CDS in monitoring concentration because these dealers can also sell CDSs to non-dealer participants. The evidence is further supported by two robustness tests — the analysis of traditional term loans and the London Whale incident. Among the three types of loan facilities, traditional term loans have the highest likelihood that CDSs are purchased by the participant lenders because banks tend to keep these loans on their balance sheets. On the other hand, institutional term loans, which are arranged with the intention to be securitized or sold to institutional investors, are less likely to have CDS protections purchased by original participant lenders. In contrast to term loans, revolvers are lines of credit, i.e., the amount of loans may not be drawn. Therefore, participant lenders also have less need to purchase CDS protections. The above main findings are driven by traditional term loans. However, there are spillover effects to revolvers that are in the same loan packages with traditional term loans. The London Whale incident, which caused JP Morgan more than $6 billion trading losses in the CDS market, presents a unique opportunity to examine the effect of CDS on lending practices. During the event quarter, there is a clear shift of lending activities from CDS selling banks to non-CDS selling banks. In addition, arranger allocation increases and syndicate size reduces among CDS selling banks relative to non-CDS selling banks. The fact that not only the lending practices of JP Morgan but also those of other CDS selling banks are affected suggests a general mistrust of using CDS protections, which in term affects the loan syndicate structures of CDS selling banks. However, the effect is transitory and reversed during the following quarter. Overall, the findings indicate that financial innovations, such as CDSs, can profoundly impact banking practices.

Corporate Governance and Debt Monitoring: The Role of Credit Default Swaps

I study the relation between internal governance and creditor governance. A deterioration in creditor governance may increase the agency costs of debt and managerial opportunism at the expense of shareholders. I exploit the introduction of credit default swaps (CDS) as a negative shock to creditor governance. I provide evidence consistent with shareholders pushing for a substitution effect between internal governance and creditor governance. Following CDS introduction, CDS firms reduce managerial risk-taking incentives relative to other firms. At the same time, after the start of CDS trading, CDS firms increase managerial wealth-performance sensitivity, board independence, and CEO turnover performance-sensitivity relative to other firms.

Corporate Leverage, Debt Maturity, and Credit Supply: The Role of Credit Default Swaps

Does the ability of suppliers of corporate debt capital to hedge risk through credit default swap (CDS) contracts impact firms' capital structures? We find that firms with traded CDS contracts on their debt are able to maintain higher leverage ratios and longer debt maturities. This is especially true during periods in which credit constraints become binding, as would be expected if the ability to hedge helps alleviate frictions on the supply side of credit markets. The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

The Role of Credit Default Swaps and Other Alternative Betas in Hedge Fund Factor Analysis

The Role of Credit Default Swaps and Other Alternative Betas in Hedge Fund Factor Analysis

Credit default swaps and risk-shifting

Credit default swaps (CDSs) are thought to ease borrowing by protecting lenders against default. This paper develops a model of the demand for CDS when borrowers choose the riskiness of investment and verification is imperfect. The model shows that CDSs may lead to risk-shifting, increasing the probability of default. Our model provides new insights into the role of CDS during the recent financial crisis.

The role of credit default swaps and other alternative betas in hedge fund factor analysis

Hedge fund factor analysis is growing in popularity. While some investors simply use traditional factor βs from the stock and bond markets, these factors do not fully explain hedge fund returns. Explanatory power of hedge fund factor analysis improves when illiquidity and non-linear exposures are explored. Alternative βs, such as commodity, currency and credit default swaps, also lead to more accurate estimates of α and β.

Corporate Leverage, Debt Maturity and Credit Supply: The Role of Credit Default Swaps

Does the ability of suppliers of corporate debt capital to hedge risk through credit default swap (CDS) contracts impact firms' capital structures? We find that firms with traded CDS contracts on their debt are able to maintain higher leverage ratios and longer debt maturities. This is especially true during periods in which credit constraints become binding, as would be expected if the ability to hedge helps alleviate frictions on the supply side of credit markets.

Corporate Leverage, Debt Maturity and Credit Supply:The Role of Credit Default Swaps

Corporate Leverage, Debt Maturity and Credit Supply:The Role of Credit Default Swaps

The Role of Credit Default Swaps on Financial Market Stability

The role of credit default swaps (CDS) in the financial crisis has been debated among regulators, market participants and academics since early 2008. CDSs are derivative instruments which enable market participants to transfer or redistribute credit risk. However, the size of the CDS market, combined with its structural opacity, concentration and interconnectedness, may be a sign that the CDS market also poses a systemic risk to financial market stability. The purpose of the article is to investigate the role of credit default swaps on financial market stability. The impact of credit default swap markets on financial market stability crucially depends on market mechanisms, and capital- liquidity requirements in financial markets.

The Role of Credit Default Swaps in the Global Crisis

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