Why Banks Use Credit Derivatives? Review Paper

The main purpose of this study is to investigate the reasons for the use of credit derivatives (CDs) by banks in risk management. It also aims to examine the extent of the use of hedging theories in the prediction of CDs. Most of the available literature which focuses on the factors that determine the use of CDs are reviewed to achieve the main purpose. The findings show that the use of hedging theories is beneficial in the prediction of CDs as hedging instruments. In addition, the decision on the use of CDs as hedging instruments is positively and consistently associated with the size of banks, costs of financial distress, the use of other risk management instruments and the level of exposure to risk. At the same time, it is negatively associated with the capital positions of the banks. With regards to the factor of the liquidity of the asset, findings on the impact of the use of CDs are contradictory. Hence, this study provides an extensive review on the factors that influence the decision on the use of CDs by banks, as well as identify the theory that supports its use. Finally, the study attempts to forecast the likelihood of using CDs for hedging by banks.