Financial Innovation in Retail and Corporate Banking
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Financial Innovation in Retail and Corporate Banking

Edited by Luisa Anderloni, David T. Llewellyn and Reinhard H. Schmidt

This valuable book discusses in detail, through a blend of theory and empirical research, the processes of innovation and the diffusion of new financial instruments.
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Chapter 10: On the Required Regulatory Support for Credit Derivative Markets

Rym Ayadi and Patrick Behr


Rym Ayadi and Patrick Behr 1 INTRODUCTION Credit derivative markets have undergone a rapid growth in the last decade. According to figures from the British Bankers’ Association, the global outstanding volume of credit derivatives was US$180 billion in 1996. Only 10 years later, at the end of 2006, the market size had expanded to a volume of more than US$20 trillion, roughly 112 times the market size of 1996. Yet, it seems that this growth has not come to an end. According to the same source, the market is expected to grow to a skyrocketing US$33 trillion by the end of 2008 (British Bankers’ Association, 2006). This tremendous growth was accompanied by the invention of new, innovative products, therewith widening the diversity of credit derivative instruments. Nowadays, market participants can issue and trade in products such as single-name credit default swaps (CDSs), credit linked notes1 (CLNs), credit spread options2 (CSOs), collateralised debt obligations3 (CDOs), equity-linked products, and portfolio products, to name just a few. The principal feature of these instruments is the separation and isolation of credit risk, which facilitates its trading and enables the replication, transfer and hedging of credit risk. Credit derivatives are mainly used for credit risk management purposes, for example for credit risk diversification across sectors and geographical regions or regulatory capital relief. Banks and insurance companies use credit derivatives mostly for these purposes. In addition, there seems to be an increasing activity in trading in credit derivatives to create additional income...

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