CDS and Credit: After the Bangs Cheaper Credit Insurance, More Lending and Hedging

Does hedging motivate CDS trading and does that affect the availability of credit? To answer these questions we couple comprehensive bank-firm level CDS trading data from the Depository Trust and Clearing Corporation with the German credit register containing bilateral bank-firm credit exposures. We find that following the Small Bang in the European CDS market, extant credit relationships with riskier firms increase banks’ CDS trading and hedging of these firms. Holding more CDS contracts of safer firms leads banks to supply relatively more credit to them. Only if banks were properly hedged before the Small Bang they take more risk.