This study finds that credit default swap (CDS) trading positively affects a firm's environmental, social, and governance (ESG) performance. This effect is more prominent in ESG strengths than ESG concerns. The proposed empirical connection remains valid across endogeneity-controlling methodologies, model specifications, and ESG performance measures. The effect is stronger for firms with stronger bank relationships, higher debt dependence, and more restrictive covenants. Furthermore, improvement in ESG performance is more pronounced for firms with more free cash flow, lower institutional ownership, and higher financial constraints. Our findings reveal the real effects of CDS trading on firm ESG performance

We study the effect of credit default swaps (CDSs) on the bond market. Using a comprehensive sample of U.S. corporate bonds, we document that the presence of CDSs significantly increases bond liquidity and reduces yield spreads for investment grade bonds. We show that CDSs influence the bond market by lowering the impact of fire sales of institutional bondholders and facilitating inventory management for bond dealers who absorb fire sale shocks. However, the liquidity provision role of CDSs gets weakened after the CDS Big Bang in 2009, potentially because of the requirement of large upfront payments

Credit default swaps (CDSs) are a major financial innovation related to debt contracting. Because CDS markets facilitate bad news being incorporated into equity prices via cross-market information spillover, CDS availability may curb firms’ information hoarding. We find that CDS trading on a firm’s debt reduces the future stock price crash risk. This effect is stronger in active CDS markets, when the main lenders are CDS market dealers with securities trading subsidiaries, or when managers have more motivation to hoard information. Our findings suggest that debt market financial innovations curtail the negative equity market effects of firms withholding bad news

This paper empirically analyses whether post-global financial crisis regulatory reforms have created appropriate incentives to voluntarily centrally clear over-the-counter (OTC) derivative contracts. We use confidential European trade repository data on single-name sovereign credit default swap (CDS) transactions and show that both seller and buyer manage counterparty exposures and capital costs, strategically choosing to clear when the counterparty is riskier. The clearing incentives seem particularly responsive to seller credit risk, which is in line with the notion that counterparty credit risk (CCR) is asymmetric in CDS contracts. The riskiness of the underlying reference entity also impacts the decision to clear as it affects both CCR capital charges for OTC contracts and central counterparty clearing house (CCP) margins for cleared contracts. Lastly, we find evidence that when a transaction helps netting positions with the CCP and hence lower margins, the likelihood of clearing is higher

This paper investigates the validity of banks' credit loss projections in the bi-annual EU-wide bank stress tests, which inform regulatory capital requirements. It finds that banks “re-optimized” their models in 2016 to bring down credit losses, exploiting flexibility in the stress test framework. Specifically, banks whose losses would have increased the most from 2014 to 2016 because of changes in the adverse scenario saw the largest decrease in projected losses thanks to model changes. Upon the release of the 2016 stress test results, stock prices and credit default swap spreads increased more for banks that achieved a greater reduction in credit losses through “re-optimization”, consistent with investors anticipating lower future capital requirements for these banks

This paper compares three methods for assessing the contagion of risk among ten Globally Significant International Banks, known as GSIBs, listed on the New York Stock Exchange with daily and weekly data sets from 2007 to 2020, based on Machine Learning and Network Analysis. In particular we identify the banks which are the largest net sources or transmitters of risk, and net receptors of risk. We also examine the response of regulatory actions, in the form of fines and BIS Bin Classification for capital adequacy. Under alternative risk measures, of Range Volatility (RV) of share prices, Credit Default Swap (CDS) premia, and Conditional Value at Risk (ΔCoVar), there is a stronger and significant connection between Contagion and the BIS Bin classifications relative to the connections between Contagion and banking fines, either in the amount or frequency of the fines. These results show that BIS bin classifications respond positively to underlying signals of increased contagion in the form of Range Volatility (RV) and ΔCoVar measures but not to CDS risk premia