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Credit Default Swaps and the Credit Crisis

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  • Rene M. Stulz

Abstract

Many observers have argued that credit default swaps contributed significantly to the credit crisis. Of particular concern to these observers are that credit default swaps trade in the largely unregulated over-the-counter market as bilateral contracts involving counterparty risk and that they facilitate speculation involving negative views of a firm's financial strength. Some observers have suggested that credit default swaps would not have made the crisis worse had they traded on exchanges. I conclude that credit default swaps did not cause the dramatic events of the credit crisis, that the over-the-counter credit default swaps market worked well during much of the crisis, and that exchange trading has both advantages and costs compared to over-the-counter trading. Though I argue that eliminating over-the-counter trading of credit default swaps could reduce social welfare, I also recognize that much research is needed to understand better and to quantify the social gains and costs of derivatives in general and credit default swaps in particular.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.73
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Bibliographic Info

Article provided by American Economic Association in its journal Journal of Economic Perspectives.

Volume (Year): 24 (2010)
Issue (Month): 1 (Winter)
Pages: 73-92

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Handle: RePEc:aea:jecper:v:24:y:2010:i:1:p:73-92

Note: DOI: 10.1257/jep.24.1.73
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References

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  1. Roberto Blanco & Simon Brennan & Ian W. Marsh, 2004. "An empirical analysis of the dynamic relationship between investment grade bonds and credit default swaps," Banco de España Working Papers 0401, Banco de España.
  2. Andrei Shleifer ad Robert W. Vishny, 1995. "The Limits of Arbitrage," Harvard Institute of Economic Research Working Papers 1725, Harvard - Institute of Economic Research.
  3. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2005. "Over-the-Counter Markets," Econometrica, Econometric Society, vol. 73(6), pages 1815-1847, November.
  4. Acharya, Viral V & Johnson, Tim, 2005. "Insider Trading in Credit Derivatives," CEPR Discussion Papers 5180, C.E.P.R. Discussion Papers.
  5. Diamond, Douglas W. & Verrecchia, Robert E., 1987. "Constraints on short-selling and asset price adjustment to private information," Journal of Financial Economics, Elsevier, vol. 18(2), pages 277-311, June.
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  7. Bernadette Minton & René Stulz & Rohan Williamson, 2009. "How Much Do Banks Use Credit Derivatives to Hedge Loans?," Journal of Financial Services Research, Springer, vol. 35(1), pages 1-31, February.
  8. Adam B. Ashcraft & Til Schuermann, 2008. "Understanding the securitization of subprime mortgage credit," Staff Reports 318, Federal Reserve Bank of New York.
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Citations

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Cited by:
  1. Podlich, Natalia & Wedow, Michael, 2011. "Credit contagion between financial systems," Discussion Paper Series 2: Banking and Financial Studies 2011,15, Deutsche Bundesbank, Research Centre.
  2. Jennie Bai & Shang-Jin Wei, 2012. "When is there a strong transfer risk from the sovereigns to the corporates? Property rights gaps and CDS spreads," Staff Reports 579, Federal Reserve Bank of New York.
  3. Delatte, Anne-Laure & Gex, Mathieu & López-Villavicencio, Antonia, 2012. "Has the CDS market influenced the borrowing cost of European countries during the sovereign crisis?," Journal of International Money and Finance, Elsevier, vol. 31(3), pages 481-497.
  4. Stefan Arping, 2012. "Credit Protection and Lending Relationships," Tinbergen Institute Discussion Papers 12-142/IV/DSF48, Tinbergen Institute.
  5. Gündüz, Yalin & Nasev, Julia & Trapp, Monika, 2013. "The price impact of CDS trading," CFR Working Papers 12-12 [rev.], University of Cologne, Centre for Financial Research (CFR).
  6. María Rodríguez-Moreno & Sergio Mayordomo & Juan Ignacio Peña, 2012. "Derivatives Holdings and Systemic Risk in the U.S. Banking Sector," Faculty Working Papers 21/12, School of Economics and Business Administration, University of Navarra.
  7. Keiler, Sebastian & Eder, Armin, 2013. "CDS spreads and systemic risk: A spatial econometric approach," Discussion Papers 01/2013, Deutsche Bundesbank, Research Centre.
  8. Bosma, Jakob & Koetter, Michael & Wedow, Michael, 2012. "Credit risk connectivity in the financial industry and stabilization effects of government bailouts," Discussion Papers 16/2012, Deutsche Bundesbank, Research Centre.
  9. Timothy J. Riddiough, 2011. "Can Securitization Work? Economic, Structural and Policy Considerations," Working Papers 242011, Hong Kong Institute for Monetary Research.
  10. Patrick Augustin, 2012. "Sovereign Credit Default Swap Premia," Working Papers 12-10, New York University, Leonard N. Stern School of Business, Department of Economics.
  11. IANCU, Aurel, 2013. "Extending Financialisation and Increasing Fragility of the Financial System," Working Papers of National Institute of Economic Research 130307, National Institute of Economic Research.
  12. Debora Revoltella & Fabio Mucci & Dubravko Mihaljek, 2010. "Properly pricing country risk: a model for pricing long-term fundamental risk applied to central and eastern European countries," Financial Theory and Practice, Institute of Public Finance, vol. 34(3), pages 219-245.
  13. Stan Cerulus, 2012. "Central clearing for credit default swaps: A legal analysis of the new central clearing regulations in Europe and the US," Journal of Financial Regulation and Compliance, Emerald Group Publishing, vol. 20(2), pages 212-244, May.
  14. Irina Stanga, 2011. "Sovereign and Bank Credit Risk during the Global Financial Crisis," DNB Working Papers 314, Netherlands Central Bank, Research Department.
  15. Lenz, Rainer, 2011. "Get rid of banks and build up a modern financial world," MPRA Paper 33501, University Library of Munich, Germany.

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