Credit derivative

In the broadest sense, any agreement by which the credit risk of a loan is shifted to a third party (any agreement by which a credit event such as a default or bankruptcy of a borrower is shifted to the contractual partner). – In a narrower sense – any financial contract that makes it possible to – separate the credit risk – of a firmly defined pool of loans, namely a basket with a limited number of loans to precisely designated borrowers – from the financing process and – make the risks tradable (place them out). – Marketability requires a high degree of standardization of the contracts, which is mostly done by reference to model contracts of the International Swaps and Derivatives Association. In addition, credit derivatives determine the amount of the agreed compensation payment independently of the actual loss suffered by a secured party (floating rate payer); this eliminates the need for an individual loss assessment. – Developed markets for the transfer of credit risks generally contribute to the stability of the international financial system. As a rule, they also increase transparency within the banks, because credit risks can be reliably assessed and adjusted more closely (more adjustable) to market conditions as a result of their marketability and tradability. Due to their faster processing of new information, credit derivatives prices have in many cases become the price leader for the cash market. – On the other hand, derivatives are making it increasingly difficult for central banks to accurately track the money supply. – In 2006, hedge funds were estimated to account for nearly sixty percent of trading in credit derivatives. – See settlement department, settlement confirmation, assets, illiquid, investment courage, credit default swap, credit-linked notes, loan-versus-paper transaction, derivatives transactions clearing requirement, derivatives transactions, bilateral, derivatives transactions reporting requirement, first-to-default basket, trading system, organized, credit risk, loan securitization, liquidity forms, market liquidity, risk, risk transformation, banking, risk assumption principle, risk taker, swap, total return swap, securitization structure, special purpose vehicle. – Cf. ECB Monthly Report of August 2002, p. 56 f., Deutsche Bundesbank Monthly Report of April 2004, p. 28 ff, Deutsche Bundesbank’s Monthly Report of December 2004, pp. 43 ff. (also overviews there), ECB’s Monthly Report of September 2005, pp. 20 ff. (focusing on the central bank’s view), BaFin’s Annual Report 2005, pp. 18 f. (data on market developments; dangers), BaFin’s Annual Report 2006, pp. 16 f. (growth forces; risk situation), Deutsche Bundesbank Monthly Report of December 2010, pp. 47 ff. (detailed explanations of the market for CDSs; important definitions; market structure data [oligopoly]; overviews; possible regulatory measures).

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University Professor Dr. Gerhard Merk, Dipl.rer.pol., Dipl.rer.oec.
Professor Dr. Eckehard Krah, Dipl.rer.pol.
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