Credit Default Swaps and the Cost of Capital
62 Pages Posted: 24 Apr 2020 Last revised: 28 Feb 2024
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: Suggested Citation