Credit Default Swaps Around the World

We analyze the impact of the introduction of credit default swaps (CDS) on real decision making within the firm, taking into consideration differences in firms’ local economic and legal environments. We extend the model of Bolton and Oehmke (2011) to take into account uncertainty 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 and find substantial evidence that the introduction of CDS affects real decisions within the firm, including those regarding leverage, investment, and the riskiness of the firm’s investments. Importantly, we find that the legal and market environments in which the reference entity operates have an influence on the impact of CDS. The effect of CDS is larger in environments where uncertainty regarding CDS obligations is reduced and where CDS 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.