Default Ambiguity: Credit Default Swaps Create New Systemic Risks in Financial Networks

Steffen Schuldenzucker (), Sven Seuken () and Stefano Battiston ()
Additional contact information
Steffen Schuldenzucker: Department of Informatics, University of Zurich, 8050 Zurich, Switzerland;
Sven Seuken: Department of Informatics, University of Zurich, 8050 Zurich, Switzerland;
Stefano Battiston: Department of Banking and Finance, University of Zurich, 8050 Zurich, Switzerland; Swiss Finance Institute, 8006 Zurich, Switzerland

Management Science, 2020, vol. 66, issue 5, 1981-1998

Abstract: We study financial networks and reveal a new kind of systemic risk arising from what we call default ambiguity —that is, a situation where it is impossible to decide which banks are in default. Specifically, we study the clearing problem : given a network of banks interconnected by financial contracts, determine which banks are in default and what percentage of their liabilities they can pay. Prior work has shown that when banks can only enter into debt contracts with each other, this problem always has a unique maximal solution. We first prove that when banks can also enter into credit default swaps (CDSs), the clearing problem may have no solution or multiple conflicting solutions, thus leading to default ambiguity. We then derive sufficient conditions on the network structure to eliminate these issues. Finally, we discuss policy implications for the CDS market.

Keywords: financial networks; credit default swaps; systemic risk; clearing systems (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (22)

Downloads: (external link)
https://doi.org/10.1287/mnsc.2019.3304 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:66:y:2020:i:5:p:1981-1998

Access Statistics for this article

More articles in Management Science from INFORMS Contact information at EDIRC.
Bibliographic data for series maintained by Chris Asher ().