If you haven’t read it, you really should wade into Frank Partnoy’s (and co-author David Skeel’s) recent paper on credit derivatives. It’s long and detailed, but Partnoy is a felicitous and smart writer, and so it’s worth it.
… we discuss the benefits associated with both types of credit derivatives, which include increased opportunities for hedging, increased liquidity, reduced transaction costs, and a deeper and potentially more efficient market for trading credit risk. We then discuss the risks associated with credit derivatives, such as moral hazard and other incentive problems, limited disclosure, potential systemic risk, high transaction costs, and the mispricing of credit. After considering the benefits and risks, we discuss some of the implications of our findings, and make some preliminary recommendations. In particular, we focus on the issues of disclosure, regulatory licenses associated with credit ratings, and the special treatment of derivatives in bankruptcy.
DAVID A. SKEEL Jr.
University of Pennsylvania Law School
University of San Diego – School of Law