CDS Auctions

56 Pages Posted: 17 Jun 2011 Last revised: 20 Jul 2012

Mikhail Chernov

UCLA Anderson

Alexander S. Gorbenko

University of Southern California - Marshall School of Business

Igor Makarov

London Business School

Multiple version iconThere are 2 versions of this paper

Date Written: June 1, 2011

Abstract

We analyze auctions for the settlement of credit default swaps (CDS) theoretically and evaluate them empirically. The requirement to settle in cash with an option to settle physically leads to an unusual two-stage process. In the first stage, participants affect the amount of the bonds to be auctioned off in the second stage. Participants in the second stage may hold positions in derivatives on the assets being auctioned. We show that the final auction price might be either above or below the fair bond price, due to strategic bidding on the part of participants holding CDS. Empirically, we observe both types of outcomes, with undervaluation occurring in most cases. We find that auctions undervalue bonds by an average of 6% on the auction day. Undervaluation is related positively to the amount of bonds exchanged in the second stage of the auction, as predicted by theory. We suggest modifications of the settlement procedure to minimize the underpricing.

Keywords: credit default swaps, auctions, settlement, open interest

JEL Classification: G10, G13, D44

Suggested Citation

Chernov, Mikhail and Gorbenko, Alexander S. and Makarov, Igor, CDS Auctions (June 1, 2011). Available at SSRN: https://ssrn.com/abstract=1866266 or http://dx.doi.org/10.2139/ssrn.1866266

Mikhail Chernov

UCLA Anderson ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Alexander S. Gorbenko

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA 90089
United States

Igor Makarov (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 (0)20 7000 8265 (Phone)
+44 (0)20 7000 8201 (Fax)

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