Credit Default Swaps and Firm Value

Credit default swaps (CDSs) may have real effects on the underlying firms when markets are incomplete. For instance, they may increase firm value by reducing supply-side credit constraints or decrease firm value by introducing inefficiencies in resolving financial distress. I find that the initiation of CDS trading is associated with lower firm valuations. The effect is stronger in active CDS markets, for riskier firms, and during periods of low counterparty risk. Consistent with a risk-based explanation, systematic risk of equity and stock returns increase following CDS initiation. I address endogeneity concerns using standard econometric methods and a quasi-natural experiment.