'Less is More' : Credit Default Swaps and Firm Cyclicality

Firm cyclicality decreases by around 40% after the inception of credit default swap (CDS) trading. The effect is due to CDS firms’ lower asset growth-GDP growth sensitivity in good times and stronger for firms facing a more severe exacting creditor problem. The cyclicality-reducing effect of CDS trading cannot be explained with bank lending cyclicality or market beta. Our finding is robust for alternative measures such as outstanding CDS positions, firm employment growth, and state-/industry level cyclicality. Moreover, CDS trading impedes unhealthy growth and enhances profitability and market value. The evidence highlights an important disciplining effect of CDS on corporate growth