Innovations in Credit Risk Transfer: Implications for Financial Stability

40 Pages Posted: 22 Jul 2008 Last revised: 3 Nov 2013

See all articles by Darrell Duffie

Darrell Duffie

Stanford University - Graduate School of Business; National Bureau of Economic Research (NBER)

Date Written: July 1, 2008

Abstract

Banks and other lenders often transfer credit risk to liberate capital for further loan intermediation. This paper aims to explore the design, prevalence and effectiveness of credit risk transfer (CRT). The focus is on the costs and benefits for the efficiency and stability of the financial system. After an overview of recent credit risk transfer activity, the following points are discussed: motivations for CRT by banks; risk retention; theories of CDO design; specialty finance companies. As an illustration of CLO design, an example is provided showing how the credit quality of the borrowers can deteriorate if efforts to control their default risks are costly for issuers. An appendix is provided on CDS index tranches.

This paper includes comments by Mohamed A El-Erian.

Keywords: Credit derivatives, credit risk transfer, financial innovations, financial stability

JEL Classification: G11, G21, G28

Suggested Citation

Duffie, James Darrell, Innovations in Credit Risk Transfer: Implications for Financial Stability (July 1, 2008). BIS Working Paper No. 255. Available at SSRN: https://ssrn.com/abstract=1165484 or http://dx.doi.org/10.2139/ssrn.1165484

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