The Use of Credit Derivatives and Banks′ Risk Taking Behaviours

Abstract Credit derivatives are financial innovations that allow transferring credit risks separately from ownership. There is a common notion that credit derivatives are useful instruments in banks′ credit risk management. However, the current credit crisis has raised a doubt towards the perception that credit derivatives make banks sounder. This paper presents empirical evidence about the effects of the use credit derivatives on banks′ risk-taking behaviours. The study uses data of 179 large U.S. commercial banks that report to the Federal Financial Institutions Examination Council, with total assets at the end of 2009 equal or greater than 3 billion dollars. The methodology used is quantitative analysis methods - the “pooled” OLS regression. In consistent with existing literature, the results strengthen the statement that the use of credit derivatives does increase banks’ risk-taking. Particularly, the volume of net credit derivatives bought is the dominant contributor.