Investment Risk, CDS Insurance and Firm Financing

47 Pages Posted: 28 Feb 2011 Last revised: 26 Aug 2016

Murillo Campello

Cornell University; National Bureau of Economic Research (NBER)

Rafael Matta

University of Amsterdam - Finance Group

Date Written: August 25, 2016

Abstract

We develop a model in which investment risk drives the demand for CDS insurance. We show that CDS overinsurance (insurance in excess of renegotiation proceeds) is procyclical and allows for greater financing of firms with positive NPV projects. In bad times, CDS overinsurance triggers the early liquidation of firms with low continuation values. Our analysis explains the benefits of CDS contracting over economic cycles and reconciles evidence showing that CDSs are most beneficial for firms that are safer and have higher continuation values. The model generates a number of empirical predictions and provides insights on the regulation of CDS markets.

Keywords: CDS, Bankruptcy, Moral Hazard, Financing Efficiency, Regulation

JEL Classification: G33, D86, D61

Suggested Citation

Campello, Murillo and Matta, Rafael, Investment Risk, CDS Insurance and Firm Financing (August 25, 2016). Available at SSRN: https://ssrn.com/abstract=1770066 or http://dx.doi.org/10.2139/ssrn.1770066

Murillo Campello

Cornell University ( email )

114 East Avenue
369 Sage Hall
Ithaca, NY 14853
United States

HOME PAGE: http://www.johnson.cornell.edu/Faculty-And-Research/Profile.aspx?id=mnc35

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138

Rafael Matta (Contact Author)

University of Amsterdam - Finance Group ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

HOME PAGE: http://www1.fee.uva.nl/pp/rmatta/

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