Credit default swaps (CDS) may be regarded as insurance transactions through which a creditor seeks protection against the risk that a borrower will default on, or be unable to service, its obligations—in other words, arrangements intended to guarantee the creditor’s claim. The premium paid to the party assuming the risk is determined by the CDS spread. As the borrower’s risk increases, CDS spreads tend to rise; accordingly, an increase in CDS spreads signals a rise in the risk profile of the borrower and, by extension, of the economy concerned.
Because CDS premiums arise from transactions between real counterparties in actual markets, whereas credit ratings rest on expert judgement, criticisms are often voiced that rating grades reflect subjective assessments. The document linked below is intended, at least in part, to shed light on these debates:
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