Premium
Credit Default Swaps and the Stability of the Banking Sector *
Author(s) -
HEYDE FRANK,
NEYER ULRIKE
Publication year - 2010
Publication title -
international review of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.489
H-Index - 18
eISSN - 1468-2443
pISSN - 1369-412X
DOI - 10.1111/j.1468-2443.2010.01104.x
Subject(s) - credit default swap , diversification (marketing strategy) , business , financial system , credit risk , monetary economics , recession , boom , financial stability , credit derivative , non performing asset , itraxx , portfolio , derivative (finance) , investment portfolio , finance , credit history , economics , credit valuation adjustment , credit reference , capital asset pricing model , marketing , environmental engineering , keynesian economics , engineering
This paper considers credit default swaps (CDSs) used for the transfer of credit risk within the banking sector. The banks' motive to conclude these CDS contracts is to improve the diversification of their credit risk. It is shown that these CDSs reduce the stability of the banking sector in a recession. However, during a boom or in periods of moderate economic up‐ or downturn, they may reduce this stability. The main reasons behind these negative impacts are firstly, that banks are induced to increase their investment in an illiquid, risky credit portfolio, and secondly, that these CDSs may create a possible channel of contagion.