Determinants of Credit Risk Derivatives Use by the European Banking Industry

Recently, global credit derivative markets have expanded very fast. The banking sector is a major user of this type of product. We intend to study the reasons why European banks use credit derivatives, analyzing to what extent the use of credit derivatives can be predicted using hedging theories. The data have been obtained from the information provided in annual reports and the Pillar 3 disclosures report. We performed the probit model estimation using panel data methodology. Our results show that the use of credit derivatives is consistent in most cases with the predictions of hedging theories. The likelihood of using credit derivatives is positively related to the bank's size, distress costs and to the use of other derivatives, and negatively related to the bank's Tier I risk capital and the level of credit risk. In addition, the aggregate analysis of exposures of European banks shows the predominance of net buying positions, unlike the American case, where the opposite occurs. This would mean that net risk exposure to these products is less for the European banking industry. Furthermore, the fact that the volume of contracts represents a very small percentage of the balance sheet suggests that the systemic risk inherent in this product is limited