Three Essays On The Effects Of Credit Default Swaps
This thesis investigates the effect of credit default swaps on firm behaviour. A credit default swap (CDS) is an insurance contract under which buyers make periodic payments over the contract's life to insure against credit events related to the underlying entities. As an efficient tool for lenders or bond investors to hedge the credit exposures associated with their investments in a firm while maintaining their control rights, the market for CDSs has developed quickly over the last two decades. The impact of this new but fast-growing credit derivative market has attracted considerable attention from financial researchers.
This thesis contains five chapters. Chapter 1 presents a brief introduction to CDSs and the research questions. Chapter 2 discusses the origins of CDS, the definition of CDS, the initiation of CDS through the over-the-counter market, the effect of CDS on creditor-debtor relationship and data sources for CDS inception.
Chapter 3 investigates how initiating a credit default swap (CDS) affects firm risk. Using the firm value volatility as a measure of firm risk, I document that firm risk decreases following the commencement of CDS trading. The CDS effect on firm risk is less pronounced for firms with more financial constraints and firms with a greater discrepancy between their bond and their CDS market. My findings reveal a significant impact of financial innovation on firms' behavior, which supports the ``empty creditor'' hypothesis. I also document that reducing expenditure levels on hiring and investment is one channel through which this negative impact occurs.
Chapter 4 empirically investigates the impact of credit default swap (CDS) inception on corporate debt maturity profiles. I show a positive relationship between CDS inception and debt maturity dispersion. This positive relationship is stronger when the credit market condition is tighter, and more pronounced for less financially constrained or higher-quality firms. My results are robust to the endogeneity of CDS trading. The findings reveal a significant effect of financial innovation on the focal firm's debt structure.
Chapter 5 examines the impact of credit default swap (CDS) inception on debt specialization. I find that firms with CDS traded on their debts tend to increase their debt specification levels. CDS inception reduces the likelihood of a strategic default, so firms specialize in fewer debt types to decrease the probability of inefficient liquidation by creditors. The positive relationship between the CDS inception and debt specialization is more pronounced for firms facing higher expected bankruptcy costs. My results are robust to the endogeneity of CDS trading and the alternative measure of debt specialization.
Chapter 6 presents a summary of the findings in Chapter 3, Chapter 4, and Chapter 5 and concludes the thesis.