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The Role of CDS Trading in the Commercialization of New Lending Relationships

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Title:The Role of CDS Trading in the Commercialization of New Lending Relationships
Authors:Kang, Jungkoo
Wittenberg-Moerman, Regina
Williams, Christopher
Keywords:Credit Default Swap
Relationship lending
Date Issued:27 Jul 2018
Abstract:We investigate how the development of the credit default swap (CDS) market affects lenders’ incentives to initiate new lending relationships. We predict that CDSs reduce the adverse selection that non-relationship lenders face when competing for loans, by allowing those lenders to hedge loan exposure and by the revelation of private information through CDS spreads. We find that, following CDS initiation on a borrower’s debt, non-relationship lead arrangers are more likely to originate its loans and non-relationship participants are more likely to join loan syndicates. We also show that lead arrangers that initiate lending relationships following CDS initiation focus more on commercial aspects of lending relationship. These lead arrangers are more likely to pursue new borrowers with high cross-selling potential, which are expected to generate substantial fee business. Further, non-relationship lenders have lower incentives for costly borrower monitoring, as reflected in weaker control rights and in the lower loan share they retain. Relative to relationship lenders, non-relationship lenders are likely to be more distant from borrowers, foreign, and less reputable once CDSs become available, emphasizing their lower monitoring efficiency.
Appears in Collections: 16 Financial: Debt and derivative instruments/Creditor protection/Risk management

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