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Pay Attention or Pay Extra: Evidence on the Compensation of Investors for the Implicit Credit Risk of Structured Products

Author

Listed:
  • Marc ARNOLD

    (University of St. Gallen)

  • Dustin SCHUETTE

    (University of St. Gallen)

  • Alexander WAGNER

    (University of Zurich and Swiss Finance Institute)

Abstract

This paper analyzes the pricing of issuer credit risk in retail structured products. After the default of Lehman Brothers, investors are compensated for the counterparty risk they bear if the products are not constructed to provide an implicit "credit enhancement", i.e., if they do not feature a sufficiently high correlation of the promised payout and the issuer's financial health. Before the financial crisis, and during the crisis up to the default of Lehman Brothers, investors are not compensated for credit risk. As the default of Lehman Brothers has arguably sharpened investors' attention for counterparty risk, these results suggest that whether issuers compensate investors for a certain risk does not only depend on the level but on investors' awareness for the corresponding risk. Our findings have regulatory and policy implications.

Suggested Citation

  • Marc ARNOLD & Dustin SCHUETTE & Alexander WAGNER, 2014. "Pay Attention or Pay Extra: Evidence on the Compensation of Investors for the Implicit Credit Risk of Structured Products," Swiss Finance Institute Research Paper Series 14-24, Swiss Finance Institute, revised Jul 2014.
  • Handle: RePEc:chf:rpseri:rp1424
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    File URL: http://ssrn.com/abstract=2419016
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    More about this item

    Keywords

    Structured products; credit risk; risk awareness;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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