Credit Default Swaps and the Cost of Capital

62 Pages Posted: 24 Apr 2020 Last revised: 28 Feb 2024

See all articles by Chunrong Wang

Chunrong Wang

Concordia University

Harjeet Bhabra

Saint Mary's University

Pascal Francois

HEC Montreal - Department of Finance

Thomas John Walker

Concordia University, Quebec - Department of Finance

Date Written: February 26, 2024

Abstract

The aim of this study is to investigate how trading in credit default swaps (CDS) affects a company's cost of capital and financing choices between 2001 and 2018. The results indicate that CDS trading can significantly decrease a company's weighted average cost of capital (WACC). Furthermore, investment-grade and non-investment grade companies use different strategies to benefit from CDS trading. Non-investment grade firms change their debt placement by relying more on arm's length debt and less on revolving credit from banks. On the other hand, investment-grade companies rely heavily on revolving credit from banks. These financing choices demonstrate the various impacts of CDS trading on companies with different credit risks. In summary, CDS trading increases rollover risk and debt renegotiation expenses for non-investment grade companies, while simultaneously decreasing capital supply-side impediments for investment-grade companies.

Keywords: Credit Default Swaps, Weighted Average Cost of Capital, Empty Creditors, Capital Structure, Public debt, Bank debt

JEL Classification: G23, G30, G32

Suggested Citation

Wang, Chunrong and Bhabra, Harjeet and Francois, Pascal and Walker, Thomas John, Credit Default Swaps and the Cost of Capital (February 26, 2024). Available at SSRN: https://ssrn.com/abstract=3565184 or http://dx.doi.org/10.2139/ssrn.3565184

Chunrong Wang

Concordia University ( email )

1455 de Maisonneuve Blvd. W.
Montreal, Quebec H3G 1M8
Canada

Harjeet Bhabra

Saint Mary's University ( email )

Sobey Building 311
923 Robie Street
Halifax, Nova Scotia B3H 3C3
Canada

Pascal Francois (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-7743 (Phone)
514-340-5632 (Fax)

Thomas John Walker

Concordia University, Quebec - Department of Finance ( email )

Montreal, Quebec H3G 1M8
Canada

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