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Credit Derivatives, Capital Requirements and Opaque OTC Markets

Author

Listed:
  • Antonio Nicolo�

    (University of University of Padua, IFS and CEPR)

  • Loriana Pelizzon

    (pelizzon@unive.it
    Department of Economics, University Of Venice Ca� Foscari)

Abstract

How does bank capital regulation affect the design of credit derivative contracts? How does the opacity of the OTC credit derivative markets affect these contracts? In this paper we address these issues and characterize the optimal security design in several settings. We show that both the level of the banks' cost of capital and the opacity of the credit derivative markets do affect the form of the optimal separating contract and the level of the banks' profits. Moreover, our results suggest that the optimal contracts are largely dependent on bank regulation. More specifically, the introduction of Basel II may prevent the use of the equity tranche in CDO contracts as a signaling device. In addition, the presence of private credit derivative contracts would make the use of signaling contracts able to solve the adverse selection problem quite expensive.

Suggested Citation

  • Antonio Nicolo� & Loriana Pelizzon, 2006. "Credit Derivatives, Capital Requirements and Opaque OTC Markets," Working Papers 2006_58, Department of Economics, University of Venice "Ca' Foscari".
  • Handle: RePEc:ven:wpaper:2006_58
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    References listed on IDEAS

    as
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    Citations

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    Cited by:

    1. Chiesa, Gabriella, 2008. "Optimal credit risk transfer, monitored finance, and banks," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 464-477, October.
    2. Arnold, Marc, 2014. "Banks’ Loan Screening Incentives with Credit Risk Transfer: An Alternative to Risk Retention," Working Papers on Finance 1402, University of St. Gallen, School of Finance.
    3. Laux, Christian, 2008. "Corporate insurance design with multiple risks and moral hazard," CFS Working Paper Series 2008/54, Center for Financial Studies (CFS).
    4. Ahn, Jung-Hyun & Breton, Régis, 2014. "Securitization, competition and monitoring," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 195-210.
    5. Arnold, Marc, 2013. "This article analyzes the impact of the introduction of centrally cleared credit risk transfer on a loan originating bank's lending discipline in the primary loan market. Under Basel III, a bank can t," Working Papers on Finance 1321, University of St. Gallen, School of Finance, revised Dec 2014.
    6. repec:eee:finmar:v:36:y:2017:i:c:p:91-114 is not listed on IDEAS
    7. 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.
    8. Chang, Chuen-Ping & Chen, Shi, 2016. "Government capital injection, credit risk transfer, and bank performance during a financial crisis," Economic Modelling, Elsevier, vol. 53(C), pages 477-486.
    9. Bülbül, Dilek & Lambert, Claudia, 2012. "Credit portfolio modelling and its effect on capital requirements," Discussion Papers 11/2012, Deutsche Bundesbank.
    10. Liu, Luke, 2011. "Securitization and moral hazard: Does security price matter?," MPRA Paper 35004, University Library of Munich, Germany.
    11. Parlour, Christine A. & Winton, Andrew, 2013. "Laying off credit risk: Loan sales versus credit default swaps," Journal of Financial Economics, Elsevier, vol. 107(1), pages 25-45.
    12. Cerasi, Vittoria & Rochet, Jean-Charles, 2014. "Rethinking the regulatory treatment of securitization," Journal of Financial Stability, Elsevier, vol. 10(C), pages 20-31.
    13. Li, Zhe & Sun, Jianfei, 2011. "Bank competition, securitization and risky investment," MPRA Paper 34173, University Library of Munich, Germany.
    14. Mayordomo, Sergio & Posch, Peter N., 2016. "Does central clearing benefit risky dealers?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 42(C), pages 91-100.
    15. Bosma, Jakob & Koetter, Michael & Wedow, Michael, 2012. "Credit risk connectivity in the financial industry and stabilization effects of government bailouts," Discussion Papers 16/2012, Deutsche Bundesbank.
    16. Chen, Zhizhen & Liu, Frank Hong & Opong, Kwaku & Zhou, Mingming, 2017. "Short-term safety or long-term failure? Empirical evidence of the impact of securitization on bank risk," Journal of International Money and Finance, Elsevier, vol. 72(C), pages 48-74.

    More about this item

    Keywords

    Credit derivatives; Signalling contracts; Capital requirements;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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