Loss Potential from Credit Derivative Use by Corporate Bond Funds under U.S. and German Regulation – A Cross Country Comparison

Artikel

This study analyzes the loss potential arising from investments into CDS and CDS use-induced risk and performance implications for a sample of large U.S. and German mutual funds. For several funds in the U.S., the regulatory potential losses arising from selling CDS protection are almost as high as net assets, while in Germany, this potential can be even higher. As opposed to the U.S. funds, German funds face a higher risk exposure, i. e. standard deviation and idiosyncratic risk, and suffer from worse performance due to the enormous selling of credit protection during the crisis. Furthermore, additional analysis of the CDS trading activity of German funds between two consecutive reporting dates suggests that period-end data overlooks many round-trip CDS trades (purchases followed by sales or the other way around) undertaken by management. Thus, funds are able to circumvent the direct leverage restrictions, which limit bank borrowing to 10 % and 33.3 % of net assets in Germany / the EU and the U.S., respectively, by using derivatives, such as CDS, and inflate overall leverage to levels that lie above the value of net assets. Based on the results, it seems advisable that regulators in both countries monitor rules restricting the speculative use of derivatives.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Journal: Credit and Capital Markets – Kredit und Kapital ; ISSN: 2199-1235 ; Volume: 49 ; Year: 2016 ; Issue: 2 ; Pages: 245-298

Classification and Topics

• Classification: Wirtschaft ; Portfolio Choice; Investment Decisions ; International Financial Markets ; Pension Funds; Non-bank Financial Institutions; Financial Instruments; Institutional Investors ; Financial Institutions and Services: Government Policy and Regulation
• Subject: Mutual funds ; leverage ; derivative ; credit default swaps ; regulation

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Gałkiewicz, Dominika P.
• Event: Veröffentlichung
• (who): Duncker & Humblot
• (where): Berlin
• (when): 2016

Further information

• DOI: doi:10.3790/ccm.49.2.245
• Last update: 10.03.2025, 11:46 AM CET