Credit Default Swap Regulation in Experimental Bond Markets

Tinbergen Institute Discussion Paper 2019-039/I

55 Pages Posted: 21 Jun 2019

See all articles by Matthias Weber

Matthias Weber

University of St. Gallen - School of Finance

John Duffy

University of California, Irvine

Arthur J. H. C. Schram

University of Amsterdam - Faculty of Economics and Business (FEB); Tinbergen Institute

Date Written: June 10, 2019

Abstract

Credit default swaps (CDS) played an important role in the financial crisis of 2008. While CDS can be used to hedge risks, they can also be used for speculative purposes (as occurred during the financial crisis) and regulations have been proposed to limit such speculative use. Here, we provide the first controlled experiment analyzing the pricing of credit default swaps in a bond market subject to default risk. We further use the laboratory as a testbed to analyze CDS regulation. Our results show that the regulation achieves the goal of increasing the use of CDS for hedging purposes while reducing the use of CDS for speculation. This success does not come at the expense of lower bond IPO revenues and does not negatively affect CDS prices or bond prices in the secondary market.

Keywords: experimental finance, asset market experiment, CDS, financial regulation, behavioral finance

JEL Classification: D53, G40, C92

Suggested Citation

Weber, Matthias and Duffy, John and Schram, Arthur J. H. C., Credit Default Swap Regulation in Experimental Bond Markets (June 10, 2019). Tinbergen Institute Discussion Paper 2019-039/I. Available at SSRN: https://ssrn.com/abstract=3401706 or http://dx.doi.org/10.2139/ssrn.3401706

Matthias Weber (Contact Author)

University of St. Gallen - School of Finance ( email )

Unterer Graben 21
St.Gallen, CH-9000
Switzerland

John Duffy

University of California, Irvine ( email )

Department of Economics
3151 Social Science Plaza
Irvine, CA 92697
United States
949-824-8341 (Phone)

Arthur J. H. C. Schram

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Roetersstraat 18
CREED
Amsterdam 1018 WB
Netherlands
+31 (0)20 525 4293 (Phone)

HOME PAGE: http://www.fee.uva.nl/creed/PEOPLE/Arthurs.htm

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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