Credit protection and lending relationships

Stefan Arping

Journal of Financial Stability, 2014, vol. 10, issue C, 7-19

Abstract: We examine the impact of credit default swaps (CDS) on lending relationships and credit market efficiency. CDS insulate lenders against losses from forcing borrowers into default and liquidation. This improves the credibility of foreclosure threats, which can have positive implications for borrower incentives and credit availability ex ante. However, lenders may also abuse their enhanced bargaining power vis-à-vis borrowers and extract excessive rents in debt renegotiations. If this hold up threat becomes severe, borrowers will be reluctant to agree to debt maturity designs or control rights transfers that would have been optimal in the absence of CDS markets. The introduction of CDS markets may then ultimately tighten credit constraints and be detrimental to welfare. Our analysis yields a number of empirical implications, some of which have been tested.

Keywords: Credit default swaps; Credit derivatives; Credit risk transfer; Financial innovation; Empty creditor problem (search for similar items in EconPapers)
JEL-codes: G2 G3 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (31)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:10:y:2014:i:c:p:7-19

DOI: 10.1016/j.jfs.2012.12.004

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