How Large Banks Use CDS to Manage Risks: Bank-Firm-Level Evidence
42 Pages Posted: 13 Jun 2015 Last revised: 20 Nov 2015
Date Written: November 19, 2015
We test five hypotheses on whether banks use CDS to hedge corporate loans, provide credit enhancements, obtain regulatory capital relief, and exploit banking relationship and private information. Using new data that link large banks’ CDS positions and syndicated lending on individual firms, we find strong evidence for the credit enhancement and regulatory capital relief hypotheses, but mixed evidence for the hedging, banking relationship, and private information hypotheses. Banks buy and sell more CDS on their borrowers, but their net CDS positions and lending status are largely unrelated. We find no evidence of bank using CDS to exploit private information.
Keywords: CDS, hedging, credit enhancement, regulatory capital relief, banking relationship, private information
JEL Classification: G14, G21, G23, G28, G32
Suggested Citation: Suggested Citation