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Credit derivatives, capital requirements and opaque OTC markets

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Author Info
Nicolò, Antonio
Pelizzon, Loriana

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Abstract

In this paper we study the optimal design of credit derivative contracts when banks have private information about their ability in the loan market and are subject to capital requirements. First, we prove that when banks are subject to a maximum loss capital requirement the optimal signaling contract is a binary credit default basket. Second, we show that if credit derivative markets are opaque then banks cannot commit to terminal-date risk exposure, and therefore the optimal signaling contract is more costly. The above results allow us to discuss the potential implications of different capital adequacy rules for the credit derivative markets.

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File URL: http://www.sciencedirect.com/science/article/B6WJD-4S9P5R3-1/2/2e9382b3f17dd6b11b0dacc873c7b572
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Publisher Info
Article provided by Elsevier in its journal Journal of Financial Intermediation.

Volume (Year): 17 (2008)
Issue (Month): 4 (October)
Pages: 444-463
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Handle: RePEc:eee:jfinin:v:17:y:2008:i:4:p:444-463

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Web page: http://www.elsevier.com/locate/inca/622875

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Keywords: Credit derivatives Signaling contracts Capital requirements;

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References listed on IDEAS
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  1. Minton, Bernadette A. & Stulz, Rene M. & Williamson, Rohan, 2005. "How Much Do Banks Use Credit Derivatives to Reduce Risk?," Working Paper Series 2005-17, Ohio State University, Charles A. Dice Center for Research in Financial Economics. [Downloadable!]
  2. Bernadette A. Minton & René Stulz & Rohan Williamson, 2005. "How Much Do Banks Use Credit Derivatives to Reduce Risk?," NBER Working Papers 11579, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Peter M. DeMarzo, 2005. "The Pooling and Tranching of Securities: A Model of Informed Intermediation," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 18(1), pages 1-35. [Downloadable!] (restricted)
  4. Gorton, Gary B. & Pennacchi, George G., 1995. "Banks and loan sales Marketing nonmarketable assets," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 389-411, June. [Downloadable!] (restricted)
  5. Leland, Hayne E & Pyle, David H, 1977. "Informational Asymmetries, Financial Structure, and Financial Intermediation," Journal of Finance, American Finance Association, vol. 32(2), pages 371-87, May. [Downloadable!] (restricted)
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  6. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June. [Downloadable!] (restricted)
  7. Cho, In-Koo & Kreps, David M, 1987. "Signaling Games and Stable Equilibria," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 179-221, May. [Downloadable!] (restricted)
  8. Duffee, Gregory R. & Zhou, Chunsheng, 2001. "Credit derivatives in banking: Useful tools for managing risk?," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 25-54, August. [Downloadable!] (restricted)
  9. Acharya, Viral V & Johnson, Tim, 2005. "Insider Trading in Credit Derivatives," CEPR Discussion Papers 5180, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  10. Allen, Franklin & Carletti, Elena, 2006. "Credit risk transfer and contagion," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 89-111, January. [Downloadable!] (restricted)
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  11. Alan Morrison, 2000. "Credit Derivatives, Disintermediation and Investment Decisions," OFRC Working Papers Series 2001fe01, Oxford Financial Research Centre. [Downloadable!]
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