Financial decisions involving credit default swaps over the business cycle

Liu Gan and Zhaojun Yang

Journal of Economic Dynamics and Control, 2024, vol. 161, issue C

Abstract: We propose a modeling approach to disentangle how idiosyncratic and aggregate shocks shape the impact of credit default swaps (CDSs) on CDS firms' financial decisions. Our relatively parsimonious model highlights a novel mechanism contributing to CDS procyclicality. We show that CDSs postpone debt renegotiation and risk-taking investment. CDS firms have higher leverage ratios than non-CDS firms. CDS firms' leverage and credit spreads are counter-cyclical. CDS firms' debt overhang is less significant than non-CDS firms. CDSs can increase or decrease CDS firms' value, depending on macroeconomic conditions, idiosyncratic risk, and borrowers' bargaining power. Empirical studies verify some model predictions.

Keywords: Credit default swaps; CDS hedging; Debt renegotiation; Risk-taking; Business cycles (search for similar items in EconPapers)
JEL-codes: G12 G32 (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:161:y:2024:i:c:s0165188924000228

DOI: 10.1016/j.jedc.2024.104830

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