Credit default swaps (CDS) are financial derivatives that act as insurance against the default of a bond or loan. The price of a CDS rises as the perceived risk of default increases, and falls as that risk decreases.

Increased Activity

Recent market activity has shown a significant increase in the trading volume of CDS, particularly those referencing subprime mortgages and other risky assets. This surge in activity suggests that investors are increasingly concerned about the potential for defaults in these sectors.

Rising Premiums

In addition to increased trading volume, the premiums (or prices) of CDS have also been rising. This means that it is becoming more expensive to insure against default, reflecting a higher perceived risk among market participants.

Factors Contributing to the Rise

• Subprime Mortgage Crisis: The ongoing turmoil in the subprime mortgage market is a major driver of CDS activity and pricing.
• Economic Slowdown: Concerns about a potential economic slowdown are also contributing to the increased demand for credit protection.
• Increased Transparency: Greater transparency in the CDS market has made it easier for investors to hedge their credit risk, further boosting activity.

Implications

The rising price of credit default swaps has several implications for the financial markets:

Higher Borrowing Costs

Increased CDS premiums can lead to higher borrowing costs for companies, as investors demand a greater return to compensate for the increased risk of default.

Potential for Losses

If a significant number of companies default, those holding CDS protection will be able to collect on their insurance policies. However, those who have sold CDS protection could face substantial losses.

Market Volatility

The increased activity and pricing of CDS can contribute to overall market volatility, as investors react to changing perceptions of credit risk.