Credit derivatives, some of the most significant developments is the financial industry, have experienced significant growth recently. The objective of this study is to examine whether the use of credit derivatives, either buying or selling, has an effect on banks loan pricing behaviour. Minton et al. (2009) propose that the net buyers of credit protection save capital and thus should be able to make loans at rates that are below the rates offered by competitors who do not utilize credit derivatives. In addition, Hirtle (2009) investigates the relationship between credit derivatives and their effects on bank lending activities. She does not find a strong association between the use of credit derivative and the supply of loans and proposes that banks are using credit derivatives mainly to provide longer maturity and lower spread loans rather than to increase the volume of loans. In contrast to previous studies, our study investigates the relation between loan prices, measured by the interest and fee income per dollar of loans, and the use of credit derivatives at BHCs. We propose that if BHCs use credit derivatives to hedge credit exposures, they would charge a lower loan rate to the borrowers since CDs enable banks to transfer the credit risk away from the lenders. However, if credit derivatives are used for purposes other than managing credit exposure, these instruments might not have any impact on loan pricing. Another goal of our study is to investigate the relationship between loan prices and the use of credit derivatives for trading purpose. We expect that during the years when BHCs are net sellers of credit derivatives, they take these positions because they have good quality loans and they are willing to take additional risk. In this case, they would report lower income per dollar of loans. However, if banks sell CDs as part of their speculative strategy, their use of credit derivatives might not have any impact on loan prices. Thus, banks would charge a rate that is similar to other banks with the same level of risk. Another goal of our study is to find, for both users and non-users of credit derivatives, how the interest and fee income generated by the BHCs is affected by the risk of default of their clients. We expect that as the risk of default increases, the prices on loans would increase as well. Banks take additional risk in exchange for higher return. Our final goal of this study is to investigate whether the use of CDs affects the supply of funds or loan rates differently for different types of loans banks hold in their portfolios. Our findings suggest that the loan prices of users of CDs are significantly less than the loan prices of nonusers. This finding may suggest that users are more efficient, competitive and diversified than nonusers and thus can afford to charge a lower rate to their clients. The result may also suggest that BHCs that are using CDs generally have lower risk loan portfolios and these portfolios are generating lower income per dollar of assets. Among the users group, we observe that as the volume of CDs purchased increases the prices of loans also increase. This suggests additional usage of CDs allows users to accept risky loans that they would not accept in the absence of CDs. They are initiating these high-risk loans to generate higher interest and fee income and at the same time they are using more CDs to hedge these risky loans. Our study also finds a significant and positive relationship between the risk of default and BHCs loan prices. Our study further investigates the users of credit derivatives during the years when these banks use CDs and the years when they do not use CDs. We find that the loan prices are marginally lower for the years when CDs are used. In particular, we find a significant decrease in prices during the years when these banks are sellers of CDs. However, we do not find any significant impact on loan prices during the years when they buy CDs. This result suggests that CD-active BHCs that buy CD protection are doing so to reduce some excessive risk they have taken without demanding a high rate to compensate for this risk. Finally, we find that the years when BHCs report both CDs bought and CDs sold, they charge a loan price that is similar to the years when these banks do not report any position in the CDs market. Perhaps the BHCs that report simultaneously CDs bought and CDs sold are selling CDs to generate income and hedging their positions through buying offsetting positions. Our analysis also suggests that the impact of the use of derivatives varies depending on whether the loans are real estate, consumer, commercial and industrial, agricultural, or foreign loans.

Includes bibliographical references (p. 36-38).

Professional Master's Project in partial fulfillment of the requirements for the degree of Master of Science (M.S.)--Worcester Polytechnic Institute. / Keywords: first-to-default baskets; multi-name credit derivatives; copula functions. Includes bibliographical references (leaf 29 ).

Thesis (Ph. D.)--Rutgers University, 2010. / "Graduate Program in Mathematics." Includes bibliographical references (p. 78-79).

Thesis (M.S.) -- Worcester Polytechnic Institute. / Keywords: Credit risk; Credit default swaps. Includes bibliographical references (leaf 32).

In recent years, concerns have been raised about the real effects of credit default swaps (CDS) on the economy. Different from the hitherto accepted view that derivatives are redundant, CDS may affect the credit risk and strategic liquidity decision of the reference entities. In this dissertation, I use a unique, comprehensive sample covering 901 CDS introductions on North American corporate issuers, between June 1997 and April 2009, to address these questions. In chapter 2, I investigate whether CDS trading increases the credit risk of the reference entities. I find that the probability of both a credit rating downgrade and bankruptcy increase after the inception of CDS trading. This finding is robust to controlling for the endogeneity of CDS trading in difference-in-difference analysis, propensity score matching, and treatment regressions with instruments. In further corroboration of our basic results, I explore the mechanism behind the increased credit risk after CDS trading, and show that firms with relatively larger amounts of CDS contracts outstanding, and those with more “no restructuring” contracts, are more adversely affected by CDS trading. In chapter 3, I further investigate the effect of CDS on corporate cash holding policies. U.S. firms are holding more cash than at any time in nearly half a century. I find that CDS trading affects corporate cash holdings. Corporate cash holdings increase after the inception of CDS trading. The impact is significant after controlling for the endogeneity of CDS trading. Moreover, cash-to-assets ratios for firms with larger CDS contracts outstanding, and those with less access to financial market are more affected by CDS trading. The impact of CDS is beyond the direct effect of line of credit on cash holdings. / published_or_final_version / Economics and Finance / Doctoral / Doctor of Philosophy

The goal of this project is to price multi-name credit derivatives using a copula approach. The properties and advantage copula functions have to other traditional methods are carefully evaluated. Monte Carlo simulations are studied and performed to obtain numerical results for copula functions with explicit and implicit forms. A model was developed to price a basic form of a first-to-default basket using different copula functions. The outcomes are analyzed and comparisons are carried out.

The objective of this project is to investigate and model the quantitative connection between market prices of credit default swaps and the market perceived probability and timing of default by the underlying borrower. We quantify the credit risk of a borrower in a two-way relationship: calculate the term structure of default probabilities from the market prices of traded CDSs and calculate prices of CDSs from the probability distribution of the time-to-default.

Thesis (Ph.D.)--Hong Kong University of Science and Technology, 2006. / Includes bibliographical references (leaves 73-75). Also available in electronic version.

In this thesis, I imply a forward-looking systematic factor from CDO market spreads; I show that this factor is a measure of CDO market's expectation of future default correlation, and I empirically show that it is positively related to bond credit spreads. From this, I infer that corporate bond credit spreads are positively related to expected default correlation. The forward-looking factor stems from a CDO valuation model that I propose. The model assumes default can be characterized as a random event that occurs with an uncertain hazard rate that is mixture-Weibull distributed. Calibrating the model to CDO market spreads implies the model parameters. Using two and three mixing densities and data spanning January 2004 to February 2008, I show that the model calibrates to both the North American and European investment grade CDOs with negligible error. The factor I imply from the CDO market quotes is the standard deviation of the implied hazard rate density. I then show that the standard deviation of the implied hazard rate density increases as default correlation increases. This is done by characterizing firms' defaults with stochastic hazard rates that are defined by jump-diffusion processes that are correlated only through the Weiner processes, only through systematic jumps, or both. I use the models to generate CDO model spreads that are used to imply mixture-Weibull hazard rate densities. In addition, I provide evidence that the implied hazard rate density standard deviation has time variation that is independent to that of other common systematic factors. Lastly, I show that bond credit spreads are positively correlated with the standard deviation of the implied hazard rate density, and I conclude that credit spreads are positively related to expected default correlation. I provide evidence that firms' credit spreads are decreasing in firm diversity; that credit spread sensitivity to default correlation is decreasing in firm equity option implied volatility and decreasing in firm diversity; and that the variation in high credit quality bond spreads is predominantly explained by systematic factors whereas the variation in low credit quality bond spreads is explained by systematic and idiosyncratic factors.