Credit default swap and two-sided moral hazard

Abstract We consider the moral hazard incentives of the CDS (Credit Default Swap) buyer and seller simultaneously and show that the CDS trading raises both the seller and buyer’s moral hazard incentive compared with the situation without the CDS trading. Moreover, we demonstrate that the effects of strengthening the capital requirement with CDS are distinct from the circumstance without the CDS trading, which should be taken into account in the capital regulation.