Howe School Seminar

Tuesday, December 4, 2012 ( 1:30 pm to 2:30 pm )

Location: BC310

Why and How Do Banks Lay off Credit Risk? The Choice between Loan Sales and Credit Default Swaps

Mehdi Beyhaghi, Ph.D.
Schulich School of Business, York University, Toronto, Canada

ABSTRACT

This paper investigates why banks use different credit risk transfer (CRT) instruments to hedge the credit risk of syndicated loans. We examine banks’ decisions to insure, sell, or continue to hold loans by considering specific characteristics of both lenders and borrowers. We find that loans to borrowers with low credit quality are more likely to be sold in the secondary loan market, but loans to borrowers with high credit quality are more likely to be hedged using credit default swaps (CDS), especially when the lenders face binding financial or regulatory constraints, which is consistent with the predictions of the theoretical literature. Interestingly, we find that bank lenders are more likely to use CDS as a hedge instrument for relatively good-quality borrowers if monitoring costs are relatively high. Finally, our results show that reputable lenders are less likely to use CRT instruments for loans with high-quality borrowers.

BIOGRAPHY

Dr. Mehdi Beyhaghi, received his Ph.D. from the Schulich School of Business, York University, Toronto, Canada. He also attended University of Waterloo, Ontario, Canada where he was awarded an M.A. Economics, and Sharif University of Technology, Tehran, Iran and earned an M.B.A B.Sc. Industrial Engineering. His fields of interest include: Banking, Risk Management, & Corporate Finance.