The Leverage Externalities of Credit Default Swaps

66 Pages Posted: 2 Nov 2014 Last revised: 13 Jun 2015

See all articles by Jay Y. Li

Jay Y. Li

University of North Carolina at Greensboro

Dragon Yongjun Tang

The University of Hong Kong - Faculty of Business and Economics

Multiple version iconThere are 2 versions of this paper

Date Written: June 8, 2015

Abstract

This paper provides the first empirical evidence of the externalities of credit default swaps (CDS). We find that a firm’s leverage is lower when a larger proportion of its revenue is derived from CDS-referenced customers. This finding is robust to alternative samples and measures, placebo tests, and the selection of customers by suppliers. Moreover, firms affected by customer CDS trading issue equity to lower leverage, and their equity issuance costs are lower. These findings are consistent with the view that CDS trading on customers improves the information environment for suppliers. Therefore, while many firms are not directly linked to CDS trading, CDS trading on their customers has spillover effects on these firms’ financial policies.

Keywords: credit default swaps, CDS, customer-supplier relationship, leverage, externalities

JEL Classification: G10, G32, L11

Suggested Citation

Li, Jay Y. and Tang, Dragon Yongjun, The Leverage Externalities of Credit Default Swaps (June 8, 2015). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2517832 or http://dx.doi.org/10.2139/ssrn.2517832

Jay Y. Li (Contact Author)

University of North Carolina at Greensboro ( email )

Department of Accounting and Finance
Greensboro, NC
United States
336 334 5647 (Phone)

Dragon Yongjun Tang

The University of Hong Kong - Faculty of Business and Economics ( email )

KKL 1004
Pokfulam Road
Pokfulam
Hong Kong
(852)22194321 (Phone)

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