Credit derivatives, capital requirements and opaque OTC markets

Antonio Nicolò, Loriana Pelizzon

Research output: Contribution to journalArticlepeer-review

Abstract

In this paper we study the optimal design of credit derivative contracts when banks have private information about their ability in the loan market and are subject to capital requirements. First, we prove that when banks are subject to a maximum loss capital requirement the optimal signaling contract is a binary credit default basket. Second, we show that if credit derivative markets are opaque then banks cannot commit to terminal-date risk exposure, and therefore the optimal signaling contract is more costly. The above results allow us to discuss the potential implications of different capital adequacy rules for the credit derivative markets. © 2008 Elsevier Inc. All rights reserved.
Original languageEnglish
Pages (from-to)444-463
Number of pages19
JournalJournal of Financial Intermediation
Volume17
Issue number4
DOIs
Publication statusPublished - Oct 2008

Keywords

  • Capital requirements
  • Credit derivatives
  • Signaling contracts

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