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Credit Default Swaps and the Credit Crisis

Credit Default Swaps and the Credit Crisis Abstract Many observers have argued that credit default swaps contributed significantly to the credit crisis. Of particular concern to these observers are that credit default swaps trade in the largely unregulated over-the-counter market as bilateral contracts involving counterparty risk and that they facilitate speculation involving negative views of a firm's financial strength. Some observers have suggested that credit default swaps would not have made the crisis worse had they traded on exchanges. I conclude that credit default swaps did not cause the dramatic events of the credit crisis, that the over-the-counter credit default swaps market worked well during much of the crisis, and that exchange trading has both advantages and costs compared to over-the-counter trading. Though I argue that eliminating over-the-counter trading of credit default swaps could reduce social welfare, I also recognize that much research is needed to understand better and to quantify the social gains and costs of derivatives in general and credit default swaps in particular. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Economic Perspectives American Economic Association

Credit Default Swaps and the Credit Crisis

Journal of Economic Perspectives , Volume 24 (1) – Feb 1, 2010

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Publisher
American Economic Association
Copyright
Copyright © 2010 by the American Economic Association
Subject
Symposia
ISSN
0895-3309
DOI
10.1257/jep.24.1.73
Publisher site
See Article on Publisher Site

Abstract

Abstract Many observers have argued that credit default swaps contributed significantly to the credit crisis. Of particular concern to these observers are that credit default swaps trade in the largely unregulated over-the-counter market as bilateral contracts involving counterparty risk and that they facilitate speculation involving negative views of a firm's financial strength. Some observers have suggested that credit default swaps would not have made the crisis worse had they traded on exchanges. I conclude that credit default swaps did not cause the dramatic events of the credit crisis, that the over-the-counter credit default swaps market worked well during much of the crisis, and that exchange trading has both advantages and costs compared to over-the-counter trading. Though I argue that eliminating over-the-counter trading of credit default swaps could reduce social welfare, I also recognize that much research is needed to understand better and to quantify the social gains and costs of derivatives in general and credit default swaps in particular.

Journal

Journal of Economic PerspectivesAmerican Economic Association

Published: Feb 1, 2010

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