Chapter 2

Credit Derivative InstrumentsPart I

In Chapter 1 we considered the concept of credit risk and credit ratings. Credit derivatives, introduced in 1993, isolate credit as a distinct asset class, much like how interest-rate derivatives, such as swaps and futures, isolated interest rates in the 1980s. This isolation of credit has improved the efficiency of the capital markets, because market participants can now separate the functions of credit origination and credit-risk bearing. Banks have been able to spread their credit risk exposure across the financial system, which arguably reduces systemic risk. They also improve market transparency by making it possible to price specific types of credit risk better.1 In this chapter, we consider the ...

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