Are CDS Auctions Biased?
Simon Fraser University (SFU) - Department of Economics
Massachusetts Institute of Technology (MIT) - Sloan School of Management
August 22, 2012
We study the design of settlement auctions for credit default swaps (CDS). We find that the one-sided design of CDS auctions currently used in practice gives CDS buyers and sellers strong incentives to distort the final auction price, in order to profit from existing CDS positions. In the absence of frictions, the current auction mechanism tends to overprice defaulted bonds given an excess supply and underprice them given an excess demand. We propose a double auction to mitigate price biases and provide robust price discovery. The predictions of our theory on bidding behavior are consistent with CDS auction data.
Number of Pages in PDF File: 49
Keywords: Credit Default Swaps, Credit Event Auctions, Price Bias, Double Auction
JEL Classification: G12, G14, D44working papers series
Date posted: April 10, 2011 ; Last revised: August 23, 2012
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