Should Derivatives Be Privileged in Bankruptcy?
Columbia Business School - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)
Columbia Business School - Finance and Economics
April 3, 2013
Derivative contracts, swaps, and repos enjoy special status in bankruptcy: they are exempt from the automatic stay and, if collateralized, are effectively senior to virtually all other claims. We propose a simple corporate finance model to assess the effect of these exemptions on a firm's cost of borrowing and incentives to engage in efficient derivative transactions. We show that, while derivatives are value-enhancing risk management tools, effective seniority for derivatives can lead to inefficiencies because it may transfer credit risk to the firm's debtholders, even though this risk could be borne more efficiently in the derivative market. Effective seniority for derivatives is only efficient if it provides sufficient diversification benefits to derivative counterparties that provide hedging services.
Number of Pages in PDF File: 52
Keywords: Derivatives, Swaps, Automatic Stay, Chapter 11, QFCs
JEL Classification: G30, G33working papers series
Date posted: March 16, 2012 ; Last revised: April 4, 2013
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