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Buying Protection from and on a Credit Derivative Product Company

A number of credit derivative product companies (CDPC) have been launched over the past few years, but the well known undercapitalization of their balance sheets has made potential hedgers skeptical about a CDPC's ability to cover its obligations as a protection seller. We argue that the availability of tradeable CDS protection on a CDPC will provide credit investors with a menu of hedging strategies that would not be available otherwise. Using a derivative pricing approach, we then propose a few exercises in comparative statics to study the determinants of the cost of CDS protection on a hypothetical CDPC specializing in senior corporate risk. Our findings contain some interesting implications about a CDPC's optimal disclosure policy.