Half-full or half-empty? Financial institutions, CDS use, and corporate credit risk

We construct a novel dataset that matches bank holding company credit default swap (CDS) positions to detailed U.S. credit registry data containing both loan and corporate bond holdings by large U.S. banks. The dataset sheds new light on how banks use CDS, and what effects, if any, CDS use has on corporate credit risk. We show that few banks insure loans, even loans of distressed borrowers, suggesting that empty creditor problems among banks are not widespread. We find that banks are more likely to sell than buy CDS when they have a lending relationship with CDS firms. We then create new aggregate measures of hedging activity based on position-level data to test the empty creditor hypothesis. Contrary to existing studies, aggregate measures of credit risk hedging that do not condition on lending relationships overstate bank hedging activity. Furthermore, our regression results do not find any evidence that firm credit risk is adversely impacted when banks in particular purchase CDS.