CDS and the Resolution of Financial Distress

8 Pages Posted: 26 Dec 2012

See all articles by Stephen J. Lubben

Stephen J. Lubben

Seton Hall University - School of Law

Rajesh Narayanan

Louisiana State University

Multiple version iconThere are 2 versions of this paper

Date Written: Fall 2012

Abstract

The dramatic growth of Credit Default Swaps (CDS) - contracts that allow creditors to hedge their default exposure or take leveraged credit positions - threatens to complicate the resolution of financial distress in ways that existing reorganization methods and institutions have yet to adapt to. CDS contracts undermine a major premise that underlies current reorganization methods - namely, that the holder of legal rights has, and is motivated by, corresponding economic interests. Because hedging in the CDS markets immunizes creditors from the debtor's financial condition, they effectively separate their legal rights and economic interests. In this article, the authors discuss the challenges this separation poses for the resolution of distress both in and out of bankruptcy, and consider ways in which “on‐ground” realities may be reconciled with the legal structure that underlies the resolution of distress. At a minimum, disclosure of CDS positions in times of financial distress - along the lines of the disclosures presently required of equity investors under the Williams Act - are an essential first step toward a solution.

Suggested Citation

Lubben, Stephen J. and Narayanan, Rajesh, CDS and the Resolution of Financial Distress (Fall 2012). Journal of Applied Corporate Finance, Vol. 24, Issue 4, pp. 129-134, 2012, Available at SSRN: https://ssrn.com/abstract=2193859 or http://dx.doi.org/10.1111/j.1745-6622.2012.00406.x

Stephen J. Lubben (Contact Author)

Seton Hall University - School of Law ( email )

One Newark Center
Newark, NJ 07102-5210
United States
973-642-8857 (Phone)

Rajesh Narayanan

Louisiana State University ( email )

Baton Rouge, LA 70803-6308
United States
225-578-6236 (Phone)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
2
Abstract Views
572
PlumX Metrics