Counterparty Risk in Financial Contracts: Should the Insured Worry About the Insurer?

47 Pages Posted: 6 Oct 2008 Last revised: 14 May 2011

James R. Thompson

University of Waterloo - School of Accounting and Finance

Date Written: October 26, 2009

Abstract

We analyze the effect of counterparty risk on financial insurance contracts, using the case of credit risk transfer in banking. This paper posits a new moral hazard problem on the insurer side of the market, which causes the insured party to be exposed to excessive counterparty risk. We find that this counterparty risk can create an incentive for the insured party to reveal superior information about the likelihood of a claim. In particular, a unique separating equilibrium may exist, even in the absence of any costly signalling device.

Keywords: Counterparty Risk, Moral Hazard, Banking, Credit Derivatives, Insurance

JEL Classification: G21, G22, D82

Suggested Citation

Thompson, James R., Counterparty Risk in Financial Contracts: Should the Insured Worry About the Insurer? (October 26, 2009). Available at SSRN: https://ssrn.com/abstract=1278084 or http://dx.doi.org/10.2139/ssrn.1278084

James R. Thompson (Contact Author)

University of Waterloo - School of Accounting and Finance ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1 N2L 3G1
Canada

HOME PAGE: http://arts.uwaterloo.ca/~james

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