We examine this market in the context of a model for corporate financing decisions which is founded upon the monitoring abilities of bankers. We show that some borrowers employ a mixture of bank and bond financing to precommit to first best behaviour and hence achieve a lower cost of funds. The secondary market in bank debt will therefore lead in some instances to wealth destruction. We argue that this destruction can be most effectively countered by the introduction of reporting requirements for credit derivatives trades. The credit derivatives market provides a liquid but opaque forum for secondary market trading of banking assets.
Credit derivatives can therefore cause disintermediation and thus reduce welfare.
I argue that this effect can be most effectively countered by the introduction of reporting requirements for credit derivatives. Return to index of Financial Economics papers.