Documentation risk in credit default swaps: When is a hedge not a hedge?

Mark Griffiths and Philip Drake
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Mark Griffiths: Stern School of Business, New York University, 44 W. 4th St., New York, NY 10012, USA

Journal of Risk Management in Financial Institutions, 2010, vol. 3, issue 1, 46-56

Abstract: In march 2000, ecobel land inc. defaulted on a bear stearns international us$10m loan initially believed to be backed by a surety bond. bear stearns international had hedged the non-payment risk with a credit default swap with aon corporation. despite alleged fraud, documentation errors and a lack of due diligence which rendered the surety bond worthless, the credit default swap represented an appropriate hedge. aon corporation, in turn, believed it had hedged its position with a credit default swap with société générale. however, documentation errors resulted in aon corporation being unhedged and liable for the us$10m plus legal fees and associated costs resulting from honouring the swap and related litigation. this paper highlights the importance of documentation in establishing appropriate hedges.

Keywords: credit default swaps; hedging; documentation risk (search for similar items in EconPapers)
JEL-codes: E5 G2 (search for similar items in EconPapers)
Date: 2010
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