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Documentation risk in credit default swaps: When is a hedge not a hedge?

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  • Griffiths, Mark
  • Drake, Philip

Abstract

In March 2000, Ecobel Land Inc. defaulted on a Bear Stearns International US$10m loan initially believed to be backed by a surety bond. Bear Stearns International had hedged the non-payment risk with a credit default swap with Aon Corporation. Despite alleged fraud, documentation errors and a lack of due diligence which rendered the surety bond worthless, the credit default swap represented an appropriate hedge. Aon Corporation, in turn, believed it had hedged its position with a credit default swap with Société Générale. However, documentation errors resulted in Aon Corporation being unhedged and liable for the US$10m plus legal fees and associated costs resulting from honouring the swap and related litigation. This paper highlights the importance of documentation in establishing appropriate hedges.

Suggested Citation

  • Griffiths, Mark & Drake, Philip, 2010. "Documentation risk in credit default swaps: When is a hedge not a hedge?," Journal of Risk Management in Financial Institutions, Henry Stewart Publications, vol. 3(1), pages 46-56, January.
    • Handle: RePEc:aza:rmfi00:y:2010:v:3:i:1:p:46-56
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    More about this item

    Keywords

    credit default swaps; hedging; documentation risk;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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