IDEAS home Printed from https://ideas.repec.org/a/cii/cepiie/2010-q3-123-5.html
   My bibliography  Save this article

The Credit Default Swap Market and the Settlement of Large Defaults

Author

Listed:
  • Virginie Coudert
  • Mathieu Gex

Abstract

The huge positions on the credit default swaps (CDS) have raised concerns about the ability of the market to settle major entities’ defaults. The near-failure of AIG and the bankruptcy of Lehman Brothers in 2008 have revealed the exposure of CDS’s buyers to counterparty risk and hence highlighted the necessity of organizing the market, which triggered a large reform process. First we analyse the vulnerabilities of the market at the bursting of this crisis. Second, we unravel the auction process implemented to settle defaults, the strategies of buyers and sellers and the links with the bond market. We then study the way it worked for key defaults, such as Lehman Brothers, Washington Mutual, CIT and Thomson, as well as for the Government Sponsored Enterprises, which reveals some oddities in the final prices. Third, we discuss the ongoing reforms aimed at strengthening the market resilience.

Suggested Citation

  • Virginie Coudert & Mathieu Gex, 2010. "The Credit Default Swap Market and the Settlement of Large Defaults," International Economics, CEPII research center, issue 123, pages 91-120.
    • Handle: RePEc:cii:cepiie:2010-q3-123-5
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S2110701713600153
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Didier Cossin & Tomas Hricko & Daniel Aunon-Nerin & Zhijiang Huang, 2002. "Exploring for the Determinants of Credit Risk in Credit Default Swap Transaction Data: Is Fixed-Income Markets’ Information Suffcient to Evaluate Credit Risk?," FAME Research Paper Series rp65, International Center for Financial Asset Management and Engineering.
    2. Jan De Wit, 2006. "Exploring the CDS-Bond Basis," Working Paper Research 104, National Bank of Belgium.
    3. Eichengreen, Barry & Mody, Ashoka & Nedeljkovic, Milan & Sarno, Lucio, 2012. "How the Subprime Crisis went global: Evidence from bank credit default swap spreads," Journal of International Money and Finance, Elsevier, vol. 31(5), pages 1299-1318.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Anouk Levels & René de Sousa van Stralen & Sînziana Kroon Petrescu & Iman van Lelyveld, 2018. "CDS market structure and risk flows: the Dutch case," DNB Working Papers 592, Netherlands Central Bank, Research Department.
    2. Christian Gouriéroux & Alain Monfort & Sarah Mouabbi & Jean-Paul Renne, 2021. "Disastrous Defaults [Risk premia and term premia in general equilibrium]," Review of Finance, European Finance Association, vol. 25(6), pages 1727-1772.
    3. Erica Paulos & Bruno Sultanum & Elliot Tobin, 2019. "CDS Auctions: An Overview," Economic Quarterly, Federal Reserve Bank of Richmond, issue 2Q, pages 105-132.
    4. Mikhail Chernov & Alexander S. Gorbenko & Igor Makarov, 2013. "CDS Auctions," Review of Financial Studies, Society for Financial Studies, vol. 26(3), pages 768-805.
    5. Coudert, V. & Gex, M., 2013. "Why the Greek CDS settlement did not lead to the feared meltdown," Financial Stability Review, Banque de France, issue 17, pages 135-150, April.
    6. Dimpfl Thomas & Peter Franziska Julia, 2013. "Using transfer entropy to measure information flows between financial markets," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 17(1), pages 85-102, February.
    7. Ma, Jason Z. & Deng, Xiang & Ho, Kung-Cheng & Tsai, Sang-Bing, 2018. "Regime-switching determinants of emerging markets sovereign credit risk swaps spread," Economics Discussion Papers 2018-52, Kiel Institute for the World Economy (IfW Kiel).
    8. Vuillemey, Guillaume & Peltonen, Tuomas A., 2015. "Disentangling the bond–CDS nexus: A stress test model of the CDS market," Economic Modelling, Elsevier, vol. 49(C), pages 32-45.
    9. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    10. Kitty Moloney & Oisin Kenny & Neill Killeen, 2016. "Network analysis using EMIR credit default swap data: micro-level evidence from Irish-domiciled special purpose vehicles (SPVs)," IFC Bulletins chapters, in: Bank for International Settlements (ed.), Combining micro and macro data for financial stability analysis, volume 41, Bank for International Settlements.
    11. Agata Kliber & Barbara Bedowska-Sojka, 2013. "Economic Situation of the Country or Risk in the World Financial Market? The Dynamics of Polish Sovereign Credit Default Swap Spreads," Dynamic Econometric Models, Uniwersytet Mikolaja Kopernika, vol. 13, pages 87-106.
    12. Lawrence Jia & Bruno Sultanum & Elliot Tobin, 2020. "Sovereign CDS Market: The Role of Dealers in Credit Events," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 3, pages 97-113.
    13. Alessandro Andreoli & Luca Vincenzo Ballestra & Graziella Pacelli, 2018. "Pricing Credit Default Swaps Under Multifactor Reduced-Form Models: A Differential Quadrature Approach," Computational Economics, Springer;Society for Computational Economics, vol. 51(3), pages 379-406, March.
    14. Bratis, Theodoros & Laopodis, Nikiforos T. & Kouretas, Georgios P., 2020. "Systemic risk and financial stability dynamics during the Eurozone debt crisis," Journal of Financial Stability, Elsevier, vol. 47(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Virginie Coudert & Mathieu Gex, 2010. "Le règlement des défauts sur le marché des credit default swaps : le cas de Lehman Brothers," Revue d'Économie Financière, Programme National Persée, vol. 97(2), pages 15-34.
    2. Game Aaron & Wu Jason, 2013. "A Covariate Residual-Based Cointegration Test Applied to the CDS-Bond Basis," Journal of Time Series Econometrics, De Gruyter, vol. 5(2), pages 163-192, April.
    3. Xiaoqing Fu & Matthew C. Li & Philip Molyneux, 2021. "Credit default swap spreads: market conditions, firm performance, and the impact of the 2007–2009 financial crisis," Empirical Economics, Springer, vol. 60(5), pages 2203-2225, May.
    4. Juan Ignacio Pe~na, 2019. "Credit Cycles, Securitization, and Credit Default Swaps," Papers 1901.00177, arXiv.org.
    5. Trapp, Monika, 2009. "Trading the bond-CDS basis: The role of credit risk and liquidity," CFR Working Papers 09-16, University of Cologne, Centre for Financial Research (CFR).
    6. Sergio Mayordomo & Juan Ignacio Peña & Juan Romo, 2011. "A New Test of Statistical Arbitrage with Applications to Credit Derivatives Markets," CNMV Working Papers CNMV Working Papers no. 4, CNMV- Spanish Securities Markets Commission - Research and Statistics Department.
    7. Giorgia Palladini & Richard Portes, 2011. "Sovereign CDS and Bond Pricing Dynamics in the Euro-area," NBER Working Papers 17586, National Bureau of Economic Research, Inc.
    8. Aaron L. Game & Jason J. Wu, 2011. "Cointegration test with stationary covariates and the CDS-bond basis during the financial crisis," Finance and Economics Discussion Series 2011-18, Board of Governors of the Federal Reserve System (U.S.).
    9. Mayordomo, Sergio & Peña, Juan Ignacio & Romo, Juan, 2009. "Are There Arbitrage Opportunities in Credit Derivatives Markets? A New Test and an Application to the Case of CDS and ASPs," DEE - Working Papers. Business Economics. WB wb096303, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    10. Pereira, John & Sorwar, Ghulam & Nurullah, Mohamed, 2018. "What drives corporate CDS spreads? A comparison across US, UK and EU firms," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 56(C), pages 188-200.
    11. Song, Wei-Ling & Uzmanoglu, Cihan, 2016. "TARP announcement, bank health, and borrowers’ credit risk," Journal of Financial Stability, Elsevier, vol. 22(C), pages 22-32.
    12. Amine Ben Amar & Ikrame Ben Slimane & Makram Bellalah, 2017. "Are Non-Conventional Banks More Resilient than Conventional Ones to Financial Crisis?," Working Papers hal-01455752, HAL.
    13. Laleh Tafakori & Armin Pourkhanali & Riccardo Rastelli, 2022. "Measuring systemic risk and contagion in the European financial network," Empirical Economics, Springer, vol. 63(1), pages 345-389, July.
    14. Frank X. Zhang, 2003. "What did the credit market expect of Argentina default? Evidence from default swap data," Finance and Economics Discussion Series 2003-25, Board of Governors of the Federal Reserve System (U.S.).
    15. Wegener, Christoph & Kruse, Robinson & Basse, Tobias, 2019. "The walking debt crisis," Journal of Economic Behavior & Organization, Elsevier, vol. 157(C), pages 382-402.
    16. Feixue Gong & Gregory Phelan, 2023. "Collateral constraints, tranching, and price bases," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 75(2), pages 317-340, February.
    17. Benjamin Hippert & André Uhde & Sascha Tobias Wengerek, 2019. "Portfolio benefits of adding corporate credit default swap indices: evidence from North America and Europe," Review of Derivatives Research, Springer, vol. 22(2), pages 203-259, July.
    18. Suzanne Salloy & Irfan Akbar Kazi, 2013. "Contagion effect due to Lehman Brothers’ bankruptcy and the global financial crisis: From the perspective of the Credit Default Swaps’ G14 dealers," Erudite Working Paper 2013-02, Erudite.
    19. Mardi Dungey & Gerald Dwyer & Thomas Flavin, 2013. "Systematic and Liquidity Risk in Subprime-Mortgage Backed Securities," Open Economies Review, Springer, vol. 24(1), pages 5-32, February.
    20. Martino, Ricci & Patrizio, Tirelli, 2017. "Subprime Mortgages and Banking in a DSGE Model," Working Papers 366, University of Milano-Bicocca, Department of Economics, revised 22 Jun 2017.

    More about this item

    Keywords

    Credit derivatives; Bankruptcy; Credit default Swap; Auction;
    All these keywords.

    JEL classification:

    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • G01 - Financial Economics - - General - - - Financial Crises
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cii:cepiie:2010-q3-123-5. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/cepiifr.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.