The Effectiveness Of Credit Derivatives On Bank Holding Company Portfolio Management

Abstract

Since their introduction in 1991, the global credit derivatives market (excluding asset swaps) has grown, exceeding previous expectations for 2003, with an estimated market of $3,548 billion or $3.5 trillion.  Growth is expected to reach $8.2 trillion by 2006 (BBA 2004).  At the time of entry to the market in the early 1990’s, it was also expected that the largest potential customers would be commercial banks that are the largest holders of risky debts.  In 2005 as in previous years, banks, securities houses and insurance companies still constitute the majority of market participants while hedge funds, which emerged as players on the buy side of the market in the last report, have this year also become major players on the sell side, and are expected to have a greater share of the market than securities houses by 2006 (BBA, 2002) While market risk allows opportunities for both profits and losses, credit risks only result in losses, and the objective of this research is to examine the effectiveness of credit derivatives as a risk management tool in improving the performance of portfolios for Bank Holding Companies (BHC’s).