Working Paper: NBER ID: w15384
Authors: Ren M. Stulz
Abstract: Many observers have argued that credit default swaps contributed significantly to the credit crisis. Of particular concern to these observers are that credit default swaps trade in the largely unregulated over-the-counter market as bilateral contracts involving counterparty risk and that they facilitate speculation involving negative views of a firm's financial strength. Some observers have suggested that credit default swaps would not have made the crisis worse had they been traded on exchanges. I conclude that credit default swaps did not cause the dramatic events of the credit crisis, that the over-the-counter credit default swaps market worked well during much of the first year of the credit crisis, and that exchange trading has both advantages and costs compared to over-the-counter trading. Though I argue that eliminating over-the-counter trading of credit default swaps could reduce social welfare, I also recognize that much research is needed to understand better and quantify the social gains and costs of derivatives in general and credit default swaps in particular.
Keywords: credit default swaps; credit crisis; financial derivatives
JEL Codes: G01; G13; G14; G18; G21; G24; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| CDS enabled the credit boom preceding the crisis (F65) | increased credit risk in the financial system (F65) |
| vast notional amounts of CDS created systemic risk (F65) | failures of major financial institutions (G28) |
| lack of transparency in the CDS market allowed for manipulations (G18) | market instability (E32) |