INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION, INC.
For Immediate Release, Thursday, December 17, 2009
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ISDA Research Notes Analyzes "Empty Creditor" Hypothesis
NEW YORK, Thursday, December 17, 2009 – The International Swaps and Derivatives Association, Inc. (ISDA) today published a detailed analysis of the issues and implications raised by the “empty creditor” hypothesis. The analysis is contained in the quarterly ISDA Research Notes, authored by David Mengle, PhD, ISDA Head of Research.
The empty creditor hypothesis relates to the effect of hedging credit risk on the behavior of creditors of distressed institutions. It posits that creditors who hedge their exposures using credit default swaps (CDS) are indifferent to a firm’s survival. Others have extended the hypothesis to suggest hedged creditors might benefit from a distressed firm’s failure and prefer that such firms file for bankruptcy rather than engage in a work-out while remaining solvent.
“The empty creditor hypothesis has generated significant interest in the press and among legal practitioners,” said Dr Mengle. “Because it could influence future regulatory policy, it is important to analyze both the logic and the evidence in support of and against it. The hypothesis is not consistent with the way CDS work or with observed behavior in debt markets.”
The Research Note states that although hedging might affect behavior because it changes one’s risk exposure, it also involves a foregone opportunity to maximize the upside of an investment. Only if such hedging could lead to systematic opportunities that might distort economic behavior or the functioning of legal institutions should it be treated as a cause for concern.
The Note segments the hypothesis into three specific and operational hypotheses:
ISDA Research Notes began publication in December 2008. The Notes, which discuss public policy issues and market trends related to the privately negotiated derivatives industry, are published by ISDA’s Research Department in New York. Dr Mengle, who heads the Research Department, also teaches at the Fordham University Graduate School of Business.
ISDA Research Notes are available at www.isda.org/researchnotes/isdaresearch.html.
ISDA, which represents participants in the privately negotiated derivatives industry, is among the world’s largest global financial trade associations as measured by number of member firms. ISDA was chartered in 1985, and today has over 830 member institutions from 58 countries on six continents. These members include most of the world’s major institutions that deal in privately negotiated derivatives, as well as many of the businesses, governmental entities and other end users that rely on over-the-counter derivatives to manage efficiently the financial market risks inherent in their core economic activities. Information about ISDA and its activities is available on the Association's web site: www.isda.org.
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