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Working Paper
Market Effects of Central Bank Credit Markets Support Programs in Europe
Using responses of credit default swap indexes to ECB monetary policy announcements, we isolate a novel credit policy component of monetary policy surprises. We examine how such unconventional monetary policy surprises affect investor perceptions of credit risk and the functioning of primary corporate debt markets. Favorable credit surprises cause declines in uncertainty about credit risk and suggest a more stable outlook on its dynamics over the following months. Both net and gross corporate bond issuance increase as a result of favorable credit surprises, with the largest response in ...
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An analysis of CDS transactions: implications for public reporting
Ongoing regulatory reform efforts aim to make the over-the-counter derivatives market more transparent by introducing public reporting of transaction-level information, including price and volume of trades. However, to date there has been a scarcity of data on the structure of trading in this market. This paper analyzes three months of global credit default swap (CDS) transactions and presents findings on the market composition, trading dynamics, and level of standardization. We find that trading activity in the CDS market is relatively low, with a majority of reference entities for ...
Journal Article
Credit derivatives and risk management
The striking growth of credit derivatives suggests that market participants find them to be useful tools for risk management. This paper illustrates credit derivatives' value with three examples: a commercial bank using credit derivatives to manage loan portfolio risk; an investment bank using them to manage the risks of underwriting securities; and an investor, such as an insurance company, asset manager, or hedge fund, using them to align credit risk exposure with a desired credit risk profile. ; But credit derivatives pose risk-management challenges of their own; the author discusses five ...
Working Paper
Credit Default Swaps
Credit default swaps (CDS) are the most common type of credit derivative. This paper provides a brief history of the CDS market and discusses its main characteristics. After describing the basic mechanics of a CDS, I present a simple valuation framework that focuses on the relationship between conditions in the cash and CDS markets as well as an approach to mark to market existing CDS positions. The discussion highlights how the 2008 global financial crisis helped shape current practices and conventions in the CDS market, including the widespread adoption of standardized coupons and upfront ...
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Are credit default swaps associated with higher corporate defaults?
Are companies with traded credit default swap (CDS) positions on their debt more likely to default? Using a proportional hazard model of bankruptcy and Merton?s contingent claims approach, we estimate the probability of default for U.S. nonfinancial firms. Our analysis does not generally find a persistent link between CDS and default over the entire period 2001-08, but does reveal a higher probability of default for firms with CDS over the last few years of that period. Further, we find that firms trading in the CDS market exhibited a higher Moody?s KMV expected default frequency during ...
Journal Article
Preface - credit derivatives: where's the risk?
This interview, conducted shortly after the Atlanta Fed's 2007 Financial Markets Conference, discusses credit derivatives and their importance to the market and outlines key themes of the conference.
Working Paper
Sovereign CDS and bond pricing dynamics in emerging markets: does the cheapest-to-deliver option matter?
We examine the relationships between credit default swap (CDS) premiums and bond yield spreads for nine emerging market sovereign borrowers. We find that these two measures of credit risk deviate considerably in the short run, due to factors such as liquidity and contract specifications, but we estimate a stable long-term equilibrium relationship for most countries. In particular, CDS premiums tend to move more than one-for-one with yield spreads, which we show is broadly consistent with the presence of a significant "cheapest-to-deliver" (CTD) option. In addition, we find a variety of ...
Working Paper
Credit derivatives and risk management
The striking growth of credit derivatives suggests that market participants find them to be useful tools for risk management. I illustrate the value of credit derivatives with three examples. A commercial bank can use credit derivatives to manage the risk of its loan portfolio. An investment bank can use credit derivatives to manage the risks it incurs when underwriting securities. An investor, such as an insurance company, asset manager, or hedge fund, can use credit derivatives to align its credit risk exposure with its desired credit risk profile.> However, credit derivatives pose risk ...
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Has the credit derivatives swap market lowered the cost of corporate debt?
There have been widespread claims that credit derivatives such as the credit default swap (CDS) have lowered the cost of firms' debt financing by creating for investors new hedging opportunities and information. However, these instruments also give banks an opaque means to sever links to their borrowers, thus reducing lender incentives to screen and monitor. In this paper, we evaluate the effect that the onset of CDS trading has on the spreads that underlying firms pay at issue when they seek funding in the corporate bond and syndicated loan markets. Employing matched-sample methods, we find ...