Should Derivatives Be Privileged in Bankruptcy?

Bolton, Patrick; Oehmke, Martin

doi:10.2139/ssrn.2023227

Should Derivatives Be Privileged in Bankruptcy?

Journal of Finance (2015), 70(6), 2352-2394

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

There 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: 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