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| Author: | Instefjord, N. |
| Title: | Risk and hedging: Do credit derivatives increase bank risk? |
| Journal: | Journal of Banking and Finance
2005 : FEB, VOL. 29:2, p. 333-345 |
| Index terms: | Finance Derivative securities Credit markets Risk Models |
| Language: | eng |
| Abstract: | This paper aims at investigating whether financial innovation of credit derivatives (hereafter as: cre-ders.) makes banks more exposed to credit risk. This paper investigates the issue in a simple model driven by costs of financial distress. The analysis identifies two effects of cre-ders. innovation - they enhance risk sharing as suggested by the hedging argument - but they also make further acquisition of risk more attractive. The latter effect, if dominant, can therefore destabilize the banking sector. The critical factor is, perhaps surprisingly, the competitive nature of the existing underlying credit markets. As these markets become more elastic the threat of destabilization increases. |
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