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Journal of Finance Vol. 70 No. 6 2015

Should Derivatives Be Privileged in Bankruptcy?

Patrick Bolton1,2,3,4,5,6,7; Martin Oehmke8,4

1 INSEAD · 2 Stockholm School of Economics · 3 Annual Reviews · 4 École Polytechnique Fédérale de Lausanne · 5 University of Rochester · 6 Columbia University · 7 European School of Management and Technology · 8 National Grid (United States)

Abstract

Derivatives enjoy special status in bankruptcy: they are exempt from the automatic stay and effectively senior to virtually all other claims. We propose a corporate finance model to assess the effect of these exemptions on a firm's cost of borrowing and incentives to engage in derivative transactions. While derivatives are value‐enhancing risk management tools, seniority for derivatives can lead to inefficiencies: it transfers credit risk to debtholders, even though this risk is borne more efficiently in the derivative market. Seniority for derivatives is efficient only if it provides sufficient cross‐netting benefits to derivative counterparties that provide hedging services.

DOI
10.1111/jofi.12201
Volume
70
Issue
6
Pages
2353-2394
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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