The Use of Credit Default Swaps by Bond Mutual Funds: Liquidity Provision and Counterparty Risk

48 Pages Posted: 12 Sep 2017 Last revised: 30 Dec 2017

See all articles by George O. Aragon

George O. Aragon

Arizona State University (ASU) - Finance Department

Lei Li

Federal Reserve Board

Jun Qian

Fanhai International School of Finance, Fudan University; University of Pennsylvania - Wharton Financial Institutions Center

Date Written: December 28, 2017

Abstract

Corporate bond mutual funds increased their selling of credit protection in the credit default swaps (CDS) market during the 2007-08 financial crisis. This trading activity was primarily in multi-name CDSs, greater among larger and established funds, and directed towards counterparty dealers in financial distress. Funds that sold credit protection during the crisis experienced greater credit market risk and superior post-crisis performance, consistent with higher expected returns from liquidity provision. Funds using Lehman Brothers as a counterparty experienced abnormal outflows and returns of -2% immediately following Lehman’s bankruptcy, suggesting that funds’ opportunistic trading in CDSs exposed investors to counterparty risk.

Keywords: bond funds, credit default swaps, crisis, liquidity provision, counterparty risk

JEL Classification: G11, G12

Suggested Citation

Aragon, George O. and Li, Lei and Qian, Jun, The Use of Credit Default Swaps by Bond Mutual Funds: Liquidity Provision and Counterparty Risk (December 28, 2017). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=3033053 or http://dx.doi.org/10.2139/ssrn.3033053

George O. Aragon (Contact Author)

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

Lei Li

Federal Reserve Board ( email )

1801 K Street NW
Washington, DC 20036
United States

Jun Qian

Fanhai International School of Finance, Fudan University ( email )

Shanghai
China
86-21-63895501 (Phone)
86-21-62934572 (Fax)

HOME PAGE: http://www.fisf.fudan.edu.cn/show-65-69.html

University of Pennsylvania - Wharton Financial Institutions Center

2306 Steinberg Hall-Dietrich Hall
Philadelphia, PA 19104
United States

HOME PAGE: http://fic.wharton.upenn.edu/fic/

Register to save articles to
your library

Register

Paper statistics

Downloads
125
rank
218,358
Abstract Views
625
PlumX Metrics