Finance and Economics Discussion Series

<p>We model the effects on banks of the introduction of a market for credit derivatives--in particular credit default swaps. A bank can use such swaps to temporarily transfer credit risks of their loans to others reducing the likelihood that defaulting loans would trigger the bank's financial distress. Because credit derivatives are more flexible at transferring risks than are other more established tools such as loan sales without recourse these instruments make it easier for banks to circumvent the ``lemons'' problem caused by banks' superior information about the credit quality of their loans. However we find that the introduction of a credit derivatives market is not necessarily desirable because it can cause other markets for loan risk-sharing to break down. In this case the existence of a credit derivatives market will lead to a greater risk of bank insolvency.</p><p>This work has been selected by scholars as being culturally important and is part of the knowledge base of civilization as we know it. This work was reproduced from the original artifact and remains as true to the original work as possible. Therefore you will see the original copyright references library stamps (as most of these works have been housed in our most important libraries around the world) and other notations in the work.</p><p>This work is in the public domain in the United States of America and possibly other nations. Within the United States you may freely copy and distribute this work as no entity (individual or corporate) has a copyright on the body of the work.</p><p>As a reproduction of a historical artifact this work may contain missing or blurred pages poor pictures errant marks etc. Scholars believe and we concur that this work is important enough to be preserved reproduced and made generally available to the public. We appreciate your support of the preservation process and thank you for being an important part of keeping this knowledge alive and relevant.</p><br>