Credit Default Swaps, an Insurance Tool That is not Insurance?• The Economic Truth - John Sneisen
In this blog post, I look at the history of this derivative that is lately gaining more and more exposure in media. I have done several videos and posts on the topic in the past. Still, I thought it would be necessary for the current market climate that we take a closer look at the "Insurance"/Bet derivative that blew up AIG in the 2007-8 financial crisis.
A credit default swap (CDS) is a financial derivative that allows investors to hedge or speculate on the credit risk of a particular debt instrument, typically a bond or loan. It functions as a form of insurance wherein one party (the protection buyer) pays a premium to another party (the protection seller) in exchange for protection against the default of a third-party debtor (the reference entity). In the event of default by the reference entity, the protection seller compensates the protection buyer for the loss. Credit default swaps have been widely used in global financial markets since the late 1990s.