CREDIT DEFAULT SWAPS AND BANK SAFETY

Abstract

In this analysis we find evidence that credit default swap (CDS) purchasesincrease bank safety. Specifically, we show banks which were net buyers ofCDS had smaller increases in loan loss reserves in response to the COVID-19crisis. Previous research had speculated that bank CDS purchases causedincreased risk-taking by banks which offset the effect of the hedge. This anal-ysis contributes to this literature on the effect of hedging on bank risk takingand capital structure. Moreover, since our results are consistent with CDSbeing effectively used to hedge, our results have implications for systemicrisk.