Credit Default Swaps and the Empty Creditor Problem

Authors / Editors

Research Areas

Publication Details

Output type: Journal article

Author list: Bolton P, Oehmke M

Publisher: Oxford University Press

Publication year: 2011

Journal: The Review of Financial Studies (0893-9454)

Volume number: 24

Issue number: 8

Start page: 2617

End page: 2655

Number of pages: 39

ISSN: 0893-9454

eISSN: 1465-7368

Languages: English-Great Britain (EN-GB)

Unpaywall Data

Open access status: green

Full text URL: https://www0.gsb.columbia.edu/faculty/pbolton/papers/rfs.hhr002.full.pdf

Abstract

The empty creditor problem arises when a debtholder has obtained insurance against default but otherwise retains control rights in and outside bankruptcy. We analyze this problem from an ex ante and ex post perspective in a formal model of debt with limited commitment, by comparing contracting outcomes with and without insurance through credit default swaps (CDS). We show that CDS, and the empty creditors they give rise to, have important ex ante commitment benefits: By strengthening creditors' bargaining power, they raise the debtor's pledgeable income and help reduce the incidence of strategic default. However, we also show that lenders will over-insure in equilibrium, giving rise to an inefficiently high incidence of costly bankruptcy. We discuss a number of remedies that have been proposed to overcome the inefficiency resulting from excess insurance.

Keywords

G30, G32, G33

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