Wednesday, March 10, 2010

Panic over Credit Default Swaps

Credit Default Swaps (CDS) are perhaps the simplest of derivatives. Therefore, it is surprising that the Presidents of European Commission and France, German Chancellor and Greek Prime Minister are worried over the impact of CDS market on sovereign standing of Greece and consequently the fate of Euro. Increased activity in the CDS market preceded the current Greek financial crisis. Hence the leaders have simplistically assumed that the CDS market is the culprit. Post hoc, ergo  propter hoc ! (After this, therefore on account of this !)

This outcry against the CDS has led to a call for ban on this derivative instrument. Volumes in the market prove that CDS is used as a speculative instrument by many players. What started as a hedging tool degenerated into a speculative weapon because of lack of regulation. The remedy therefore is to strengthen the regulatory framework. Throwing the baby with the bathwater betrays lack of maturity.

1 comment:

Rupa Bose said...

Quite so. And the same point about regulation might be made about many different areas of the economy.