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Has the development of the structured credit market affected the cost of corporate debt?

  • Adam Ashcraft
  • Joao Santos

The rapid development of structured credit markets permits investors to assume credit risk that in aggregate is frequently many times larger than the amount of debt actually issued by an underlying borrower. Given the apparent increased appetite for corporate credit risk by investors, and the additional information revealed in the structured credit markets, a natural question to ask is whether the development of these markets has been associated with a reduction in the cost of debt financing, giving firms an opportunity to operate with greater leverage. Using Markit data identifying when trading in credit default swaps begins for each borrower, we fail to find any evidence of that CDS trading has an impact on syndicated loan spreads or non-price terms for the average firm. However, we document evidence that CDS trading helps borrowers issue syndicated loans more frequently and take on more leverage relative to a matched sample of untraded firms, consistent with an increase in credit supply.

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Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2006)
Issue (Month): Nov ()
Pages:

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Handle: RePEc:fip:fedfpr:y:2006:i:nov:x:15
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  1. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2004. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market," NBER Working Papers 10418, National Bureau of Economic Research, Inc.
  2. Diamond, Douglas W. & Verrecchia, Robert E., 1987. "Constraints on short-selling and asset price adjustment to private information," Journal of Financial Economics, Elsevier, vol. 18(2), pages 277-311, June.
  3. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
  4. Frank X. Zhang, 2003. "What did the credit market expect of Argentina default? Evidence from default swap data," Finance and Economics Discussion Series 2003-25, Board of Governors of the Federal Reserve System (U.S.).
  5. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2789-2811, November.
  6. Santos, Joao A.C., 2006. "Why firm access to the bond market differs over the business cycle: A theory and some evidence," Journal of Banking & Finance, Elsevier, vol. 30(10), pages 2715-2736, October.
  7. Jan Ericsson & Kris Jacobs & Rodolfo A. Oviedo, 2004. "The Determinants of Credit Default Swap Premia," CIRANO Working Papers 2004s-55, CIRANO.
  8. Berger, Allen N. & Udell, Gregory F., 1990. "Collateral, loan quality and bank risk," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 21-42, January.
  9. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
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