TY - JOUR
T1 - Laying off credit risk
T2 - Loan sales versus credit default swaps
AU - Parlour, Christine A.
AU - Winton, Andrew
PY - 2013/1
Y1 - 2013/1
N2 - How do markets for debt cash flow rights, with and without accompanying control rights, affect the efficiency of lending? A bank makes a loan, learns if it needs monitoring, and then decides whether to lay off credit risk. The bank can transfer credit risk by either selling the loan or buying a credit default swap (CDS). With a CDS, the originating bank retains the loan's control rights; with loan sales, control rights pass to the loan buyer. Credit risk transfer leads to excessive monitoring of riskier credits and insufficient monitoring of safer credits. Increases in banks' cost of equity capital exacerbate these effects. For riskier credits, loan sales typically dominate CDS but not for safer credits. Once repeated lending and consequent reputation concerns are modeled, although CDSs remain dominated by loan sales for riskier credits, for safer credits they can dominate loan sales, supporting better monitoring (albeit to a limited extent) while allowing efficient risk sharing. Restrictions on the bank's ability to sell the loan expand the range in which CDSs are used and monitoring is too low.
AB - How do markets for debt cash flow rights, with and without accompanying control rights, affect the efficiency of lending? A bank makes a loan, learns if it needs monitoring, and then decides whether to lay off credit risk. The bank can transfer credit risk by either selling the loan or buying a credit default swap (CDS). With a CDS, the originating bank retains the loan's control rights; with loan sales, control rights pass to the loan buyer. Credit risk transfer leads to excessive monitoring of riskier credits and insufficient monitoring of safer credits. Increases in banks' cost of equity capital exacerbate these effects. For riskier credits, loan sales typically dominate CDS but not for safer credits. Once repeated lending and consequent reputation concerns are modeled, although CDSs remain dominated by loan sales for riskier credits, for safer credits they can dominate loan sales, supporting better monitoring (albeit to a limited extent) while allowing efficient risk sharing. Restrictions on the bank's ability to sell the loan expand the range in which CDSs are used and monitoring is too low.
KW - Control rights
KW - Credit default swaps
KW - Credit risk
KW - G21
KW - G28
KW - G32
KW - Loan sales
UR - http://www.scopus.com/inward/record.url?scp=84870366057&partnerID=8YFLogxK
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U2 - 10.1016/j.jfineco.2012.08.004
DO - 10.1016/j.jfineco.2012.08.004
M3 - Article
AN - SCOPUS:84870366057
SN - 0304-405X
VL - 107
SP - 25
EP - 45
JO - Journal of Financial Economics
JF - Journal of Financial Economics
IS - 1
ER -