Credit default swaps around the world: Investment and financing effects

We analyze the impact of credit default swaps (CDS) introduction on real decision-making within the firm, taking into account differences in the local economic and legal environment of firms. We extend the model of Bolton and Oehmke (2011) in order to consider uncertainty regarding whether the actions taken by the reference entity will trigger credit events for the CDS obligations. We test the predictions of the model in a sample of more than 56,000 firms across 50 countries over the period 2001-2015. We find substantial evidence that the introduction of CDS affects real decisions within the firm, including leverage, investment, and the risk of investments taken by the firm. Importantly, we find that the legal and market environment in which the reference entity operates has an influence on the impact of CDS. The effect of CDS is larger where uncertainty regarding their obligations is reduced, and where they mitigate weak property rights. Our results shed light on the incomplete nature of CDS contracts in international capital markets, related to significant legal uncertainty surrounding the interpretation of underlying credit events.