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Credit Default Swaps and the Credit Crisis

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  • René 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 been 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 first year of the credit 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 quantify the social gains and costs of derivatives in general and credit default swaps in particular.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15384.

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Date of creation: Sep 2009
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Publication status: published as Rene M. Stulz, 2010. "Credit Default Swaps and the Credit Crisis," Journal of Economic Perspectives, American Economic Association, vol. 24(1), pages 73-92, Winter.
Handle: RePEc:nbr:nberwo:15384

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  1. Acharya, Viral V & Johnson, Tim, 2005. "Insider Trading in Credit Derivatives," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5180, C.E.P.R. Discussion Papers.
  2. Diamond, Douglas W. & Verrecchia, Robert E., 1987. "Constraints on short-selling and asset price adjustment to private information," Journal of Financial Economics, Elsevier, Elsevier, vol. 18(2), pages 277-311, June.
  3. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2005. "Over-the-Counter Markets," Econometrica, Econometric Society, Econometric Society, vol. 73(6), pages 1815-1847, November.
  4. Adam B. Ashcraft & Til Schuermann, 2008. "Understanding the securitization of subprime mortgage credit," Staff Reports, Federal Reserve Bank of New York 318, Federal Reserve Bank of New York.
  5. 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 Espa�a Working Papers 0401, Banco de Espa�a.
  6. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, American Finance Association, vol. 52(1), pages 35-55, March.
  7. Roberto Blanco & Simon Brennan & Ian W. Marsh, 2005. "An Empirical Analysis of the Dynamic Relation between Investment-Grade Bonds and Credit Default Swaps," Journal of Finance, American Finance Association, American Finance Association, vol. 60(5), pages 2255-2281, October.
  8. Minton, Bernadette & Stulz, Rene & Williamson, Rohan, 2008. "How Much Do Banks Use Credit Derivatives to Hedge Loans?," Working Paper Series, Ohio State University, Charles A. Dice Center for Research in Financial Economics 2008-1, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
  9. Rajesh K. Aggarwal & Guojun Wu, 2006. "Stock Market Manipulations," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 79(4), pages 1915-1954, July.
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