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Journal of Economic Perspectives: Vol. 24 No. 1 (Winter 2010)

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Credit Default Swaps and the Credit Crisis

Article Citation

Stulz, Rene M. 2010. "Credit Default Swaps and the Credit Crisis." Journal of Economic Perspectives, 24(1): 73-92.

DOI: 10.1257/jep.24.1.73

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.

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Authors

Stulz, Rene M. (OH State U)

JEL Classifications

E44: Financial Markets and the Macroeconomy
G01: Financial Crises
G13: Contingent Pricing; Futures Pricing; option pricing
G20: Financial Institutions and Services: General
G32: Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure

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