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Credit derivatives: an overview

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  • David Mengle
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    Abstract

    Arising from financial institutions' need to hedge and diversify credit risk, credit derivatives have now become a major investment tool. Almost all credit derivatives take the form of the credit default swap, which transfers default risk from one party to another. Most credit default swaps were once written on single names, but since 2004 the major impetus to growth and market liquidity has been credit default swaps on indexes. ; This paper examines the mechanics, risks, and market for credit default swaps, provides an overview of pricing and dealers' risk-management role, discusses the costs and benefits of credit derivatives, and outlines some recent policy issues. ; The author notes that, in the early years of credit derivatives, the major challenges facing these instruments involved resolving ambiguities in reference entities and defining credit events. Since the introduction of index trading and the widespread entry of hedge funds, however, the challenges have been settlement after credit events and addressing operational backlogs stemming from an increase in novations. Now that hedge funds are an established part of the market, the next important issue is likely to be whether credit derivatives activity will move to exchanges.

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    Bibliographic Info

    Article provided by Federal Reserve Bank of Atlanta in its journal Economic Review.

    Volume (Year): (2007)
    Issue (Month): Q4 ()
    Pages: 1 - 24

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    Handle: RePEc:fip:fedaer:y:2007:i:q4:p:1-24:n:v.92no.4

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    Related research

    Keywords: Credit derivatives;

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    Cited by:
    1. Dudek, Jérémy, 2013. "Illiquidité, contagion et risque systémique," Economics Thesis from University Paris Dauphine, Paris Dauphine University, number 123456789/13236 edited by Le Fol, Gaëlle, November.
    2. Levitin, Adam & Wachter, Susan, 2012. "Explaining the Housing Bubble," MPRA Paper 41920, University Library of Munich, Germany.
    3. M. Kabir Hassan & Thiti S. Ngow & Jung Suk-Yu, 2011. "Determinants of Credit Default Swaps in International Markets," NFI Working Papers 2011-WP-01, Indiana State University, Scott College of Business, Networks Financial Institute.
    4. 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.
    5. Ferro, Gustavo & Castagnolo, Fermando, 2010. "Seguros, crisis, regulación y disciplina del mercado
      [Insurance, crisis, regulation and market discipline]
      ," MPRA Paper 25593, University Library of Munich, Germany, revised 01 Oct 2010.

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