Are CDS Auctions Biased and Inefficient?
Simon Fraser University (SFU) - Department of Economics
Massachusetts Institute of Technology (MIT) - Sloan School of Management
December 7, 2013
We study the design of settlement auctions for credit default swaps (CDS) and the associated price efficiency and allocative efficiency. Implemented as a two-stage mechanism, CDS auctions determine the insurance payments from CDS sellers to CDS buyers, following the defaults of corporations and sovereigns. Using a simple model of divisible auction, we characterize equilibrium strategies in both stages of the auction. Various restrictions currently imposed in the auction prevent the full participation of certain investors, leading to systematically biased prices and inefficient post-auction allocations. Imposing price caps and floors can mitigate price bias but exacerbate allocative inefficiency. We propose a double auction that delivers robust price discovery and more efficient allocations.
Number of Pages in PDF File: 50
Keywords: Credit Default Swaps, Credit Event Auctions, Price Bias, Allocative Efficiency, Double Auction
JEL Classification: G12, G14, D44working papers series
Date posted: April 10, 2011 ; Last revised: December 8, 2013
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