Potential Costs of CDSs

Christopher L. Culp (), Andria van der Merwe () and Bettina J. Stärkle ()
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Christopher L. Culp: Johns Hopkins University
Andria van der Merwe: Johns Hopkins University
Bettina J. Stärkle: Compass Lexecon

Chapter Chapter 8 in Credit Default Swaps, 2018, pp 147-154 from Palgrave Macmillan

Abstract: Abstract Credit default swaps (“CDSs”) can give rise to potential costs: (i) lenders hedging borrower credit exposures could use CDSs to justify extending riskier loans, not doing sufficient up-front due diligence, and/or underinvesting in ongoing credit risk monitoring of borrowers; (ii) lenders hedging the credit exposure of borrowers could be biased toward forcing borrowers into bankruptcy in lieu of pursuing debt restructurings; (iii) speculators with synthetic shorts in reference entity obligations could precipitate excessive price volatility; and (iv) systemic linkages across financial institutions resulting from CDS counterparty exposures could exacerbate the spillover effects and severity of major financial firm’s failures. We discuss here these potential costs of CDSs.

Keywords: Credit default swap; CDS; Strategic default; Empty creditor; Credit risk monitoring; Speculation; Volatility; Spillover effects; Interconnectedness; Systemic risk (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1007/978-3-319-93076-3_8

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