Should Derivatives Be Privileged in Bankruptcy?

58 Pages Posted: 16 Mar 2012 Last revised: 10 Dec 2015

See all articles by Patrick Bolton

Patrick Bolton

Columbia University - Columbia Business School, Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Martin Oehmke

London School of Economics & Political Science (LSE) - Department of Finance; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: March 5, 2014

Abstract

Derivatives enjoy special status in bankruptcy: They are exempt from the automatic stay and effectively senior to virtually all other claims. We propose a corporate finance model to assess the effect of these exemptions on a firm's cost of borrowing and its incentives to engage in efficient derivative transactions. While derivatives are value-enhancing risk management tools, seniority for derivatives can lead to inefficiencies: It transfers credit risk to debtholders, even though this risk is borne more efficiently in the derivative market. Seniority for derivatives is efficient only if it provides sufficient cross-netting benefits to derivative counterparties that provide hedging services.

Keywords: Derivatives, Swaps, Automatic Stay, Chapter 11, QFCs, Safe Harbors

JEL Classification: G30, G33

Suggested Citation

Bolton, Patrick and Oehmke, Martin, Should Derivatives Be Privileged in Bankruptcy? (March 5, 2014). Journal of Finance (2015), 70(6), 2352-2394, Available at SSRN: https://ssrn.com/abstract=2023227 or http://dx.doi.org/10.2139/ssrn.2023227

Patrick Bolton

Columbia University - Columbia Business School, Economics ( email )

420 West 118th Street
New York, NY 10027
United States

HOME PAGE: http://www0.gsb.columbia.edu/faculty/pbolton/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Martin Oehmke (Contact Author)

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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