Documentation risk in credit default swaps: When is a hedge not a hedge?
Abstract
In march 2000, ecobel land inc. defaulted on a bear stearns international us$10m loan initially believed to be backed by a surety bond. bear stearns international had hedged the non-payment risk with a credit default swap with aon corporation. despite alleged fraud, documentation errors and a lack of due diligence which rendered the surety bond worthless, the credit default swap represented an appropriate hedge. aon corporation, in turn, believed it had hedged its position with a credit default swap with société générale. however, documentation errors resulted in aon corporation being unhedged and liable for the us$10m plus legal fees and associated costs resulting from honouring the swap and related litigation. this paper highlights the importance of documentation in establishing appropriate hedges.
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Author's Biography
Mark Griffiths is the Jack Anderson Professor of Finance at Miami University's Farmer School of Business and a Visiting Professor of Finance at NYU-Stern School of Business. His primary research areas include money markets and the economics of entrepreneurship. Dr Griffiths holds a BA from the University of Western Ontario, a BA and an MBA from York University, and MA (economics) from the University of Waterloo and a PhD from the University of Western Ontario.
Philip Drake is a Clinical Professor in the School of Accountancy. He holds a BS in accounting (cum laude) from the University of Alabama and an MA and PhD from The Ohio State University. Dr Drake is a licensed CPA in Texas and holds a Certified Financial Planner designation and an Accredited Investment Fiduciary Auditor designation.
Citation
Griffiths, Mark and Drake, Philip (2010, January 1). Documentation risk in credit default swaps: When is a hedge not a hedge?. In the Journal of Risk Management in Financial Institutions, Volume 3, Issue 1. https://doi.org/10.69554/HMUR1471.
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