Credit Default Swaps – A Survey

Foundations and Trends® in Finance: Vol. 9: No. 1–2, pp 1-196

199 Pages Posted: 3 Dec 2014 Last revised: 13 Jan 2015

See all articles by Patrick Augustin

Patrick Augustin

McGill University, Desautels Faculty of Management

Marti G. Subrahmanyam

New York University (NYU) - Department of Finance

Dragon Yongjun Tang

The University of Hong Kong - Faculty of Business and Economics

Sarah Qian Wang

University of Warwick - Warwick Business School

Date Written: December 1, 2014

Abstract

Credit default swaps (CDS) have been growing in importance in the global financial markets. However, their role has been hotly debated, in industry and academia, particularly since the credit crisis of 2007-2009. We review the extant literature on CDS that has accumulated over the past two decades. We divide our survey into seven topics after providing a broad overview in the introduction. The second chapter traces the historical development of CDS markets and provides an introduction to CDS contract definitions and conventions. The third chapter discusses the pricing of CDS, from the perspective of no-arbitrage principles, structural and reduced-form credit risk models. It also summarizes the literature on the determinants of CDS spreads, with a focus on the role of fundamental credit risk factors, liquidity and counterparty risk. The fourth chapter discusses how the development of the CDS market has affected the characteristics of the bond and equity markets, with an emphasis on market efficiency, price discovery, information flow and liquidity. Attention is also paid to the CDS-bond basis, the wedge between the pricing of the CDS and its reference bond, and the mispricing between the CDS and the equity market. The fifth chapter examines the effect of CDS trading on firms’ credit and bankruptcy risk, and how it affects corporate financial policy, including bond issuance, capital structure, liquidity management, and corporate governance. The sixth chapter analyzes how CDS impact the economic incentives of financial intermediaries. The seventh chapter reviews the growing literature on sovereign CDS and highlights the major differences between the sovereign and corporate CDS markets. In the eight chapter, we discuss CDS indices, especially the role of synthetic CDS index products backed by residential mortgage-backed securities during the financial crisis. We close with our suggestions for promising future research directions on CDS contracts and markets.

Suggested Citation

Augustin, Patrick and Subrahmanyam, Marti G. and Tang, Dragon Yongjun and Wang, Sarah Qian, Credit Default Swaps – A Survey (December 1, 2014). Foundations and Trends® in Finance: Vol. 9: No. 1–2, pp 1-196, Available at SSRN: https://ssrn.com/abstract=2532799

Patrick Augustin

McGill University, Desautels Faculty of Management ( email )

1001 Sherbrooke Street West
Quebec
Montreal, Quebec H3A 1G5
Canada

HOME PAGE: http://www.patrickaugustin.se

Marti G. Subrahmanyam

New York University (NYU) - Department of Finance ( email )

Stern School of Business,
44 West 4th Street, Suite 9-68
New York, NY 10012-1126
United States
212-998-0348 (Phone)
212-995-4233 (Fax)

Dragon Yongjun Tang

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

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

Sarah Qian Wang (Contact Author)

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

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