"Less is More": Credit Default Swaps and Firm Cyclicality

61 Pages Posted: 11 Mar 2021 Last revised: 30 Nov 2021

See all articles by Lars Norden

Lars Norden

Getulio Vargas Foundation (FGV) - Brazilian School of Public and Business Administration (EBAPE); Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças

Chao Yin

University of Edinburgh

Lei Zhao

ESCP Business School

Date Written: November 30, 2021

Abstract

Firm cyclicality, measured as firm asset growth-GDP growth sensitivity, decreases by around 40% after the inception of credit default swap (CDS) trading. The effect is mainly observed in good times and stronger for firms facing a more severe exacting creditor problem. The cyclicality-reducing effect of CDS trading cannot be explained with bank lending cyclicality or market beta. Our finding is robust for alternative measures such as outstanding CDS positions, firm employment growth, and state-/industry level cyclicality. Moreover, CDS trading impedes unhealthy firm growth and enhances profitability and firm value. Overall, our paper reveals a new real effect of financial innovations on firm cyclicality and highlights an important disciplining effect of CDS on corporate growth.

Keywords: Credit default swaps, real effects of financial markets, exacting creditors, asset growth, employment growth

JEL Classification: G32, G33, G34

Suggested Citation

Norden, Lars and Yin, Chao and Zhao, Lei, "Less is More": Credit Default Swaps and Firm Cyclicality (November 30, 2021). Proceedings of Paris December 2021 Finance Meeting EUROFIDAI - ESSEC, Available at SSRN: https://ssrn.com/abstract=3801151 or http://dx.doi.org/10.2139/ssrn.3801151

Lars Norden (Contact Author)

Getulio Vargas Foundation (FGV) - Brazilian School of Public and Business Administration (EBAPE) ( email )

Rua Jornalista Orlando Dantas 30
Rio de Janeiro, 22231-010
Brazil
+552130832431 (Phone)

HOME PAGE: http://www.larsnorden.de

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças ( email )

Praia de Botafogo 190/1125, CEP
Rio de Janeiro RJ 22253-900
Brazil

Chao Yin

University of Edinburgh ( email )

Lei Zhao

ESCP Business School ( email )

79 Avenue de la République
Paris, 75011
France

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