Changes in Corporate Investment Policy following the Inception of Credit Default Swap Trade

• In Event: Information and credit prices

Abstract

Prior studies show that after a lender receives insurance on its loan via a credit default swap, it reduces monitoring of its client’s activities as well as aiding its distressed client. We make two contrasting predictions about how the client would change its investment policy in response. It could reduce risky investments to lower its vulnerability to financial distress or it could pursue volatility-enhancing projects to increase the value of call options built into its shareholder investments. We find that the borrower shifts to a more conservative policy, but only when its managers have low portfolio sensitivity to stock return volatility.

Authors

• hyun (Shana) a hong, University of California-Riverside

• Ji Woo Ryou, University of Texas Rio Grande Valley-Edinburg

• Anup Srivastava, Dartmouth College