Abstract

Derivatives enjoy special status in bankruptcy: They are exempt from the automatic stay and effectively senior to virtually all other claims. We propose a corporate finance model to assess the effect of these exemptions on a firm's cost of borrowing and its incentives to engage in efficient derivative transactions. While derivatives are value-enhancing risk management tools, seniority for derivatives can lead to inefficiencies: It transfers credit risk to debtholders, even though this risk is borne more efficiently in the derivative market. Seniority for derivatives is efficient only if it provides sufficient cross-netting benefits to derivative counterparties that provide hedging services.

Download PDF

Citation

Bolton, Patrick, and Martin Oehmke. "Should Derivatives Be Privileged in Bankruptcy?" Journal of Finance (forthcoming).

Each author name for a Columbia Business School faculty member is linked to a faculty research page, which lists additional publications by that faculty member.

Each topic is linked to an index of publications on that topic.