Credit Default Swaps and Credit Risk Reallocation

We use data on granular holdings of debt and Credit Default Swaps (CDS) referencing non-financial corporations across financial investors, to investigate how CDS reallocate credit risk and whether this increases investor-level riskiness. To guide our investigation, we propose a methodology to disentangle CDS positions between three strategies: hedging, speculation, and arbitrage. In our dataset, arbitrage remains anecdotal. We find that CDS reduce exposure concentration, as hedgers shed off their most concentrated exposures, while speculators substitute debt for CDS. CDS also facilitate risk-taking by speculators. Overall, CDS increase portfolio risk metrics, due to a limited effect of hedging strategies compared to speculative ones