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Credit protection and lending relationships

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  • Arping, Stefan

Abstract

We examine the impact of credit default swaps (CDS) on lending relationships and credit market efficiency. CDS insulate lenders against losses from forcing borrowers into default and liquidation. This improves the credibility of foreclosure threats, which can have positive implications for borrower incentives and credit availability ex ante. However, lenders may also abuse their enhanced bargaining power vis-à-vis borrowers and extract excessive rents in debt renegotiations. If this hold up threat becomes severe, borrowers will be reluctant to agree to debt maturity designs or control rights transfers that would have been optimal in the absence of CDS markets. The introduction of CDS markets may then ultimately tighten credit constraints and be detrimental to welfare. Our analysis yields a number of empirical implications, some of which have been tested.

Suggested Citation

  • Arping, Stefan, 2014. "Credit protection and lending relationships," Journal of Financial Stability, Elsevier, vol. 10(C), pages 7-19.
    • Handle: RePEc:eee:finsta:v:10:y:2014:i:c:p:7-19
    DOI: 10.1016/j.jfs.2012.12.004
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    More about this item

    Keywords

    Credit default swaps; Credit derivatives; Credit risk transfer; Financial innovation; Empty creditor problem;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance

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