Three Essays on Credit Default Swap Market

Recently, the market for credit derivatives proliferated over the past two decades and has been blamed heavily for the recent financial crisis. As a result, academic researchers have been paying close attention to the role of the Credit Default Swap (CDS) market in different aspects of the financial market. This dissertation examines the role of the Loan only Credit Default Swap Market in the primary loan market. The first chapter investigates the informational role of the Loan-only Credit Default Swap index (LCDX) in the costs of contemporaneous loans, particularly individual loan spread. The results show that there is a significant positive effect of the spread of the LCDX on the loan spread. The second chapter looks at how credit default swaps affect banks’ risk sharing behavior in syndicated loans. The LCDX allows banks to transfer the credit risk of borrowers in an alternative way. Thus, this paper investigates an important question on whether loan syndication and the LCDX are complementary or substitutive methods to share the risk for banks. The finding shows that lead banks retain more shares of a syndicated loan once the LCDX price increases. This finding indicates that lead banks use the loan syndication and credit derivatives as complementary risk-sharing tools. The third paper investigates the mean-variance efficiency of the market for credit default swaps that satisfies the restrictions and assumptions of the Capital Asset Pricing Model (CAPM). The result shows that the CDS market is not as efficient as the equity market. The spread of a single-name CDS is priced not only through overall market equilibrium but also through the idiosyncratic risk premium from the underlying firms