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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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    Citations

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    Cited by:

    1. Arping, Stefan, 2014. "Credit protection and lending relationships," Journal of Financial Stability, Elsevier, vol. 10(C), pages 7-19.
    2. Wolf Wagner, 2009. "Banking fragility and liquidity creation: options as a substitute for deposits," Annals of Finance, Springer, vol. 5(1), pages 125-129, January.
    3. Pagès, H., 2009. "Bank incentives and optimal CDOs," Working papers 253, Banque de France.
    4. Chiesa, Gabriella, 2008. "Optimal credit risk transfer, monitored finance, and banks," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 464-477, October.
    5. Jeong-Bon Kim & Li Li & Mary L. Z. Ma & Frank M. Song, 2013. "CEO Option Compensation, Risk-Taking Incentives, and Systemic Risk in the Banking Industry," Working Papers 182013, Hong Kong Institute for Monetary Research.
    6. Ismailescu, Iuliana & Phillips, Blake, 2015. "Credit default swaps and the market for sovereign debt," Journal of Banking & Finance, Elsevier, vol. 52(C), pages 43-61.
    7. Achim Wambach, 2006. "Outside-Director Liability: A Policy Analysis. Comment," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 162(1), pages 26-31, March.
    8. Oehmke, Martin & Zawadowski, Adam, 2015. "Synthetic or real? The equilibrium effects of credit default swaps on bond markets," LSE Research Online Documents on Economics 84511, London School of Economics and Political Science, LSE Library.
    9. Goderis, Benedikt & Wagner, Wolf, 2009. "Credit Derivatives and Sovereign Debt Crises," MPRA Paper 17314, University Library of Munich, Germany.
    10. Allen, Franklin & Carletti, Elena, 2006. "Credit risk transfer and contagion," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 89-111, January.
    11. Marti G. Subrahmanyam & Dragon Yongjun Tang & Sarah Qian Wang, 2012. "Does the Tail Wag the Dog? The Effect of Credit Default Swaps on Credit Risk," Working Papers 292012, Hong Kong Institute for Monetary Research.
    12. repec:eee:jfinec:v:124:y:2017:i:2:p:395-414 is not listed on IDEAS
    13. Stefan Arping, 2013. "Proprietary Trading and the Real Economy," Tinbergen Institute Discussion Papers 13-032/IV/DSF52, Tinbergen Institute.
    14. Darrell Duffie, 2008. "Innovations in credit risk transfer: implications for financial stability," BIS Working Papers 255, Bank for International Settlements.
    15. Marc Chesney & Delia Coculescu & Selim Gökay, 2016. "Endogenous trading in credit default swaps," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 39(1), pages 1-31, April.
    16. Batchimeg Sambalaibat, 2012. "Credit Default Swaps and Sovereign Debt with Moral Hazard and Debt Renegotiation," 2012 Meeting Papers 1093, Society for Economic Dynamics.
    17. Patrick Bolton & Martin Oehmke, 2011. "Credit Default Swaps and the Empty Creditor Problem," Review of Financial Studies, Society for Financial Studies, vol. 24(8), pages 2617-2655.
    18. Victoria COCIUG & Victoria POSTOLACHE (DOGOTARI), 2015. "Implications Of Credit Risk Transfer On Bank Performances," ECONOMY AND SOCIOLOGY: Theoretical and Scientifical Journal, Socionet;Complexul Editorial "INCE", issue 3, pages 87-95.
    19. Marti G. Subrahmanyam & Dragon Yongjun Tang & Sarah Qian Wang, 2016. "Credit Default Swaps, Exacting Creditors and Corporate Liquidity Management," Working Papers 202016, Hong Kong Institute for Monetary Research.
    20. Marsh, Ian W., 2006. "The effect of lenders' credit risk transfer activities on borrowing firms' equity returns," Research Discussion Papers 31/2006, Bank of Finland.
    21. Kim, Gi H., 2016. "Credit derivatives as a commitment device: Evidence from the cost of corporate debt," Journal of Banking & Finance, Elsevier, vol. 73(C), pages 67-83.
    22. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.

    More about this item

    Keywords

    Credit default swaps; Credit derivatives; Credit risk transfer; Financial innovation; Empty creditor problem;

    JEL classification:

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

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