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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 ...
Journal Article
Credit derivatives: an overview
Arising from financial institutions' need to hedge and diversify credit risk, credit derivatives have now become a major investment tool. Almost all credit derivatives take the form of the credit default swap, which transfers default risk from one party to another. Most credit default swaps were once written on single names, but since 2004 the major impetus to growth and market liquidity has been credit default swaps on indexes. ; This paper examines the mechanics, risks, and market for credit default swaps, provides an overview of pricing and dealers' risk-management role, discusses the ...
Journal Article
Credit derivatives, macro risks, and systemic risks
This paper explores some bigger-picture risks associated with credit derivatives. Drawing a distinction between the market's perception of credit and "real credit" as reflected in the formal definition of a credit event, the author examines the well-documented macro drivers of credit generally. ; The author next enumerates frequently cited concerns with credit derivatives: the exceedingly large notional trade in credit default swaps relative to outstanding debt, the increasing involvement of hedge funds in these products, and operational concerns that have surfaced in the past year or two. ...
Journal Article
Did you know? A primer on credit default swaps
A credit default swap, an over-the-counter financial contract that allows for the transfer of credit risk from one party to another, is one way financial institutions mitigate and diversify credit risk.
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 ...
Report
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 ...
Report
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
Bernanke: rules should not stifle innovation
Report
Credit derivatives and bank credit supply
Credit derivatives are the latest in a series of innovations that have had a significant impact on credit markets. Using a micro data set of individual corporate loans, this paper explores whether use of credit derivatives is associated with an increase in bank credit supply. The author finds evidence that greater use of credit derivatives is associated with greater supply of bank credit for large term loans--newly negotiated loan extensions to large corporate borrowers--though not for (previously negotiated) commitment lending. This finding suggests that the benefits of the growth of credit ...