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Financial crisis of 2007 has raised serious concerns regarding
soundness of financial system. It has been pointed out by several
academic scholars that root cause of recent turmoil is embedded
deep and closely connected with innovation in credit risk transfer.
This study examines the motives behind creation of derivative
market and their role in financial meltdown. Among the credit
derivatives the two most widely used or abused tools, credit
default swaps and collateralized debt obligations, played a
significant role in rapid establishment of credit derivative
universe thereby leaving behind the long established equity market.
The study further examines original concept of credit risk transfer
along with their funding structure and dynamics of different tools
highlighting the role of Regulators, Rating Agencies, Financial
Institutions & contagion effects of innovation on financial
industry and establishment of shadow banking. The study concludes
on quotation of Terri Duhond that when car crash happens people
only blame drivers rather than criticizing the authorities who
allow them to drive.
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