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Should Derivatives Be Privileged in Bankruptcy?

Author

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  • PATRICK BOLTON
  • MARTIN OEHMKE

Abstract

Derivatives enjoy special status in bankruptcy: they are exempt from the automatic stay and effectively senior to virtually all other claims. We propose a corporate finance model to assess the effect of these exemptions on a firm's cost of borrowing and incentives to engage in derivative transactions. While derivatives are value‐enhancing risk management tools, seniority for derivatives can lead to inefficiencies: it transfers credit risk to debtholders, even though this risk is borne more efficiently in the derivative market. Seniority for derivatives is efficient only if it provides sufficient cross‐netting benefits to derivative counterparties that provide hedging services.

Suggested Citation

  • Patrick Bolton & Martin Oehmke, 2015. "Should Derivatives Be Privileged in Bankruptcy?," Journal of Finance, American Finance Association, vol. 70(6), pages 2353-2394, December.
    • Handle: RePEc:bla:jfinan:v:70:y:2015:i:6:p:2353-2394
    DOI: 10.1111/jofi.12201
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