Investment risk, CDS insurance, and firm financing

Murillo Campello and Rafael Matta

European Economic Review, 2020, vol. 125, issue C

Abstract: We develop a model in which investment risk drives the demand for CDS insurance. The model shows the efficiency of CDS contracting over the state of the economy. It shows that CDS overinsurance (insurance in excess of renegotiation surpluses) is procyclical, allowing for greater financing when the probability of default is lower. Our theory predicts that the incidence of so-called “empty creditors” is largely constrained to firms that are safer, face lower bankruptcy costs, have more severe management-creditor agency problems, and whose assets are costlier to verify. Our analysis generates a number of empirical predictions and provides new insights into the regulation of CDS markets.

Keywords: CDS; Bankruptcy; Moral hazard; Financing efficiency; Regulation (search for similar items in EconPapers)
JEL-codes: D61 D86 G33 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:125:y:2020:i:c:s0014292120300568

DOI: 10.1016/j.euroecorev.2020.103424

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