Nº 20-15: Identifying Empty Creditors with a Shock and Micro-Data

Firms with credit default swaps (CDS) traded on their debt may face hedged creditors who have less incentive to participate in firm restructuring. To elucidate this empty creditor effect, we develop a theoretical model of CDS trading, and its impact on the probability of default of CDS firms, their investment and the cost of trading. Studying unique data on bank-firm CDS net notional and credit exposures, we find that the attenuation of the empty creditor effect decreases corporate default probabilities and CDS spreads, and increases total bank credit. The effect attentuation further varies with firm, bank-firm, and creditor hedging characteristics.