We examine the effect 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.
Che, Yeon-Koo, and Rajiv Sethi.
"Credit Market Speculation and the Cost of Capital."
American Economic Journal: Microeconomics,
Economics of Contract: Theory
Contingent Pricing; Futures Pricing; option pricing
Capital Budgeting; Fixed Investment and Inventory Studies; Capacity