Center for Financial Studies

We examine the effects of credit default swaps (CDS), a major type of over-thecounter derivative, on the corporate liquidity management of the reference firms. CDS help firms to access the credit market since the lenders can hedge their credit risk more easily using these contracts. However, CDS-protected creditors can be tougher in debt renegotiations and less willing to support distressed borrowers, causing some firms to become more cautious. Consequently, we find that firms hold significantly more cash after the inception of CDS trading on their debt. The increase in cash holdings by CDS firms is more pronounced for financially constrained firms and firms facing higher refinancing risk. Moreover, bank relationships and outstanding credit facilities intensify the CDS effect on cash holding. Finally, firms with greater financial expertise hold more cash when their debt is referenced by CDS. These findings suggest that CDS, which are primarily a risk management tool for lenders, induce firms to adopt more conservative liquidity policies. ∗We thank Lauren Cohen, Miguel Ferreira, Andrea Gamba, Robin Greenwood, Jarrad Harford, Victoria Ivashina, Andrew Karolyi, Beni Lauterbach, Kai Li, Chen Lin, Tse-chun Lin, Ron Masulis, Joshua Pollet, Henri Servaes, Laura Starks, René Stulz, Toni Whited, and seminar and conference participants at the University of Hong Kong, the University of Warwick, the University of Münster, the 2012 NTU International Conference on Finance, the 2012 SFM Conference at the National Sun Yat-sen University, the 2013 European Finance Association Meetings, and the 2014 Jerusalem Finance Conference for helpful comments on previous drafts of this paper. Credit Default Swaps and Corporate Cash Holdings