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Should Derivatives Be Privileged in Bankruptcy?

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

Patrick Bolton

Columbia Business School - Department of 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; Columbia Business School - Finance and Economics

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 Business School - Department of 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)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 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

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

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