Credit Derivatives: Macro-Risk Issues Credit Derivatives, Macro Risks, and Systemic Risks

In this paper, some of the “bigger picture ” risks associated with credit derivatives are explored. After drawing a distinction between the market’s perception of credit and “real credit ” as reflected in the formal definition of a “credit event”, an examination of the macro drivers of credit generally (which might then prove to be one of the catalysts for larger scale concerns with credit derivatives) is undertaken; these have been fairly well researched and documented. Next, the most frequently cited concerns with the modern credit derivative marketplace are enumerated: the exceedingly large notional traded in credit default swaps alone relative to (i.e., integer multiples of) the outstanding supply of debt (bonds and loans) in any single name, the increasing involvement of the hedge fund community in these products, and the operational concerns (lack of timely confirmations,…) which have come to light (and been publicly and roundly criticized) in the last year or two. The possibilities of associated systemic risk are subsequently considered. Credit derivatives deal with risk, involve the transfer of risk, and are, potentially, risky in and of themselves. As in any “new”market, there have been some “glitches”; some of these issues have already been addressed by the market participants and some of these entail the evolvin