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Credit Derivatives in Banking: Useful Tools for Managing Risk?

Greg Duffee and Chunseng Zhou

Research Program in Finance, Working Paper Series from Research Program in Finance, Institute for Business and Economic Research, UC Berkeley

Abstract: We model the effects on banks of the introduction of a market for credit derivatives; in particular, credit-default swaps. A bank can use such swaps to temporarily transfer credit risks of their loans to others, reducing the likelihood that defaulting loans trigger the bank's financial distress. Because credit derivatives are more flexible at transferring risks than are other, more established tools such as loan sales without recourse, these instruments make it easier for banks to circumvent the "lemons" problem caused by banks' superior information about the credit quality of their loans. However, we find that the introduction of a credit-derivatives market is not necessarily desirable because it can cause other markets for loan risk-sharing to break down.

Keywords: credit-default swaps, bank loans, loan sales, asymmetric information; G21, D82 (search for similar items in EconPapers)
Date: 1999-11-01
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Related works:
Journal Article: Credit derivatives in banking: Useful tools for managing risk? (2001) Downloads
Working Paper: Credit Derivatives in Banking: Useful Tools for Managing Risk? (1999) Downloads
Working Paper: Credit derivatives in banking: useful tools for managing risk? (1997) Downloads
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