Should Derivatives be Privileged in Bankruptcy? / Patrick Bolton, Martin Oehmke.

Format:

Book

Author/Creator:

Bolton, Patrick.

Contributor:

National Bureau of Economic Research.

Oehmke, Martin.

Series:

Working Paper Series (National Bureau of Economic Research) no. w17599.

NBER working paper series no. w17599

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2011.

Summary:

Derivative contracts, swaps, and repos enjoy "super-senior" status in bankruptcy: they are exempt from the automatic stay on debt and collateral collection that applies to virtually all other claims. We propose a simple corporate finance model to assess the effect of this exemption on firms' cost of borrowing and incentives to engage in swaps and derivatives transactions. Our model shows that while derivatives are value-enhancing risk management tools, super-seniority for derivatives can lead to inefficiencies: collateralization and effective seniority of derivatives shifts credit risk to the firm's creditors, even though this risk could be borne more efficiently by derivative counterparties. In addition, because super-senior derivatives dilute existing creditors, they may lead firms to take on derivative positions that are too large from a social perspective. Hence, derivatives markets may grow inefficiently large in equilibrium.

Notes:

Print version record

November 2011.