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Credit Market Speculation and the Cost of Capital †

Credit Market Speculation and the Cost of Capital † Abstract We examine the effects of speculation using credit derivatives on the cost of debt and the likelihood of default. The availability of credit default swaps induces investors who are optimistic about borrower revenues to sell protection instead of buying bonds. This benefits borrowers if protection can only be bought with an insurable interest, but can increase the cost of debt and crowd out productive lending if protection can be purchased as a bet on default. We also show that the possibility of speculation on default may cause multiple equilibria and exacerbate the problem of rollover risk. (JEL D86, G13, G31 ) http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Journal: Microeconomics American Economic Association

Credit Market Speculation and the Cost of Capital †

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Publisher
American Economic Association
Copyright
Copyright © 2014 by the American Economic Association
Subject
Articles
ISSN
1945-7685
eISSN
1945-7685
DOI
10.1257/mic.6.4.1
Publisher site
See Article on Publisher Site

Abstract

Abstract We examine the effects of speculation using credit derivatives on the cost of debt and the likelihood of default. The availability of credit default swaps induces investors who are optimistic about borrower revenues to sell protection instead of buying bonds. This benefits borrowers if protection can only be bought with an insurable interest, but can increase the cost of debt and crowd out productive lending if protection can be purchased as a bet on default. We also show that the possibility of speculation on default may cause multiple equilibria and exacerbate the problem of rollover risk. (JEL D86, G13, G31 )

Journal

American Economic Journal: MicroeconomicsAmerican Economic Association

Published: Nov 1, 2014

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