Pay Attention or Pay Extra: Evidence on the Compensation of Investors for the Implicit Credit Risk of Structured Products

Marc Arnold, Dustin Schuette and Alexander Wagner
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Marc Arnold: University of St. Gallen
Dustin Schuette: University of St. Gallen

No 14-24, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: This paper analyzes the pricing of issuer credit risk in retail structured products. After the default of Lehman Brothers, investors are compensated for the counterparty risk they bear if the products are not constructed to provide an implicit "credit enhancement", i.e., if they do not feature a sufficiently high correlation of the promised payout and the issuer's financial health. Before the financial crisis, and during the crisis up to the default of Lehman Brothers, investors are not compensated for credit risk. As the default of Lehman Brothers has arguably sharpened investors' attention for counterparty risk, these results suggest that whether issuers compensate investors for a certain risk does not only depend on the level but on investors' awareness for the corresponding risk. Our findings have regulatory and policy implications.

Keywords: Structured products; credit risk; risk awareness (search for similar items in EconPapers)
JEL-codes: D8 G34 M52 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2014-03, Revised 2014-07
New Economics Papers: this item is included in nep-ban and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1424

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