UT Dallas Researchers Connect Credit Default Swaps to Mortgage Delinquencies
For the first time, researchers have empirically connected credit default swaps to the mortgage defaults that helped trigger the Great Recession. The study was authored at the Naveen Jindal School of Management at the University of Texas at Dallas by finance and managerial economics professor Dr. Harold H. Zhang and associate professor Dr. Feng Zhao. Their research was published in The Journal of Finance.
“There are many media reports that to some extent link the financial crisis to the housing market crash, and subsequently, research has confirmed that,” explained Zhang. “One of the issues that people have paid particular attention to is the role played by derivative securities, and in this case, credit default swaps.”
To study the impact of credit default swaps on mortgage delinquencies, Zhang and Zhao collaborated with the global asset management firm TCW and studied more than 9 million subprime mortgages issued from 2003 to 2007 that were privately securitized. They found that mortgages originated with credit default swap coverage had a significantly higher likelihood of becoming delinquent than loans that were issued without credit default swap coverage. The researchers also noted that banks placed their riskiest subprime mortgages in pools with credit default swap contracts.
Zhang and Zhao believe that the study has policy implications. Zhang explains: ““If you look at home insurance, health insurance, life insurance, it’s a much regulated industry, but with credit default swap there is no regulation. No one really knows how many policies have been issued or how many are outstanding. There should be a centralized clearing house collecting all this information.”
Zhang and Zhao’s study, Subprime Mortgage Defaults and Credit Default Swaps, is available online.
