35 Pages Posted: 1 Mar 2010
This paper considers credit default swaps (CDSs) used for the transfer of credit risk within the banking sector. The banks' motive to conclude these CDS contracts is to improve the diversification of their credit risk. It is shown that these CDSs reduce the stability of the banking sector in a recession. However, during a boom or in periods of moderate economic up- or downturn, they may reduce this stability. The main reasons behind these negative impacts are firstly, that banks are induced to increase their investment in an illiquid, risky credit portfolio, and secondly, that these CDSs may create a possible channel of contagion.
Suggested Citation: Suggested Citation
Heyde, Frank and Neyer, Ulrike, Credit Default Swaps and the Stability of the Banking Sector. International Review of Finance, Vol. 10, Issue 1, pp. 27-61, March 2010. Available at SSRN: https://ssrn.com/abstract=1560184 or http://dx.doi.org/10.1111/j.1468-2443.2010.01104.x
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