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Are CDS Auctions Biased and Inefficient?

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  • SONGZI DU
  • HAOXIANG ZHU

Abstract

We study the design of credit default swaps (CDS) auctions, which determine the payments by CDS sellers to CDS buyers following defaults of bonds. Using a simple model, we find that the current design of CDS auctions leads to biased prices and inefficient allocations. This is because various restrictions imposed in CDS auctions prevent certain investors from participating in the price discovery and allocation process. The imposition of a price cap or floor also gives dealers large influence on the final auction price. We propose an alternative double auction design that delivers more efficient price discovery and allocations.

Suggested Citation

  • Songzi Du & Haoxiang Zhu, 2017. "Are CDS Auctions Biased and Inefficient?," Journal of Finance, American Finance Association, vol. 72(6), pages 2589-2628, December.
    • Handle: RePEc:bla:jfinan:v:72:y:2017:i:6:p:2589-2628
    DOI: 10.1111/jofi.12541
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    Cited by:

    1. Nina Boyarchenko & Anna M. Costello & Or Shachar, 2020. "The Long and Short of It: The Post-Crisis Corporate CDS Market," Economic Policy Review, Federal Reserve Bank of New York, vol. 26(3), pages 1-49, June.
    2. Augustin, Patrick & Saleh, Fahad & Xu, Haohua, 2020. "CDS Returns," Journal of Economic Dynamics and Control, Elsevier, vol. 118(C).
    3. Augustin, Patrick & Sokolovski, Valeri & Subrahmanyam, Marti G. & Tomio, Davide, 2022. "How sovereign is sovereign credit risk? Global prices, local quantities," Journal of Monetary Economics, Elsevier, vol. 131(C), pages 92-111.

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