This paper investigates whether, and through which channel, the active use of credit derivatives changes bank behavior in the credit market, and how this channel was affected by the crisis of 2007–2009. Our principal finding is that banks with larger gross positions in credit derivatives charge significantly lower corporate loan spreads, while banks' net positions are not consistently related to loan pricing. We argue that this is consistent with banks passing on risk management benefits to corporate borrowers but not with alternative channels through which credit derivative use may affect loan pricing. We also find that the magnitude of the risk management effect remained unchanged during the crisis period of 2007–2009. In addition, banks with larger gross positions in credit derivatives cut their lending by less than other banks during the crisis and have consistently lower loan charge-offs. In sum, our study is suggestive of significant risk management benefits from financial innovations that persist under adverse conditions – that is, when they matter most.

Additional Metadata
Keywords Financial innovation, Credit derivatives, Syndicated loans, Loan pricing, Financial crisis
JEL General Financial Markets (jel G1), Financial Institutions and Services (jel G2)
Persistent URL hdl.handle.net/1765/115290
Series ERIM Top-Core Articles
Journal Journal of Economic Dynamics and Control
Citation
Norden, L, Silva Buston, C, & Wagner, W.B. (2014). Financial innovation and bank behavior: Evidence from credit markets. Journal of Economic Dynamics and Control. Retrieved from http://hdl.handle.net/1765/115290