Credit Risk Transfer: To Sell Or To Insure

James Thompson ()

No 1131, Working Paper from Economics Department, Queen's University

Abstract: This paper analyzes credit risk transfer in banking. Specifically, we model loan sales and loan insurance (e.g. credit default swaps) as the two instruments of risk transfer. Recent empirical evidence suggests that the adverse selection problem is as relevant in loan insurance as it is in loan sales. Contrary to previous literature, this paper allows for informational asymmetries in both markets. We show how credit risk transfer can achieve optimal investment and minimize the social costsassociated with excess risk taking by a bank. Furthermore, wefind that no separation of loan types can occur in equilibrium. Our results show that a well capitalized bank will tend to use loan insurance regardless of loan quality in the presence of moralhazard and relationship banking costs of loan sales. Finally, we show that a poorly capitalized bank may be forced into the loan sales market, even in the presence of possibly significant relationship and moral hazard costs that can depress the selling price.

Keywords: credit risk transfer; banking; loan sales; loan insurance; credit derivatives (search for similar items in EconPapers)
JEL-codes: D82 G21 G22 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2007-06
New Economics Papers: this item is included in nep-ban, nep-fmk and nep-ias
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

Downloads: (external link)
https://www.econ.queensu.ca/sites/econ.queensu.ca/files/qed_wp_1131.pdf First version 2007 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:qed:wpaper:1131

Access Statistics for this paper

More papers in Working Paper from Economics Department, Queen's University Contact information at EDIRC.
Bibliographic data for series maintained by Mark Babcock ().