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CDS Auctions

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Author Info

  • Mikhail Chernov

    ()

  • Alexander S.Gorbenko

    ()

  • Igor Makarov

    ()

Abstract

We analyse credit default swap settlement auctions theoretically and evaluate them empirically. In our theoretical analysis, we show that the current auction design may not result in the fair bond price and suggest modifications to the auction design to minimize mispricing. In our empirical study, we find support for our theoretical predictions. We show that an auction undervalues bonds by 10%, on average, on the day of the auction and link this undervaluation to the number of bonds that are exchanged during the auction. We also document a V-shaped pattern in underpricing during the days surrounding the auction: in the days leading up to the auction, the extent to which bonds are underpriced declines, while after the auction, the extent to which they are underpriced increases, with the smallest underpricing coming on the day of the auction.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/DP688%20PWC26.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp688.

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Date of creation: Jul 2011
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Handle: RePEc:fmg:fmgdps:dp688

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Web page: http://www.lse.ac.uk/fmg/

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  1. Nicolae Gârleanu & Lasse Heje Pedersen, 2011. "Margin-Based Asset Pricing and Deviations from the Law of One Price," NBER Working Papers 16777, National Bureau of Economic Research, Inc.
  2. Virginie Coudert & Mathieu Gex, 2010. "The Credit Default Swap Market and the Settlement of Large Defaults," Economie Internationale, CEPII research center, issue 123, pages 91-120.
  3. Patrick Bolton & Martin Oehmke, 2011. "Credit Default Swaps and the Empty Creditor Problem," Review of Financial Studies, Society for Financial Studies, vol. 24(8), pages 2617-2655.
  4. Acharya, Viral V & Johnson, Tim, 2005. "Insider Trading in Credit Derivatives," CEPR Discussion Papers 5180, C.E.P.R. Discussion Papers.
  5. Ilan Kremer & Kjell G. Nyborg, 2004. "Divisible-Good Auctions: The Role of Allocation Rules," RAND Journal of Economics, The RAND Corporation, vol. 35(1), pages 147-159, Spring.
  6. Back, Kerry & Zender, Jaime F, 1993. "Auctions of Divisible Goods: On the Rationale for the Treasury Experiment," Review of Financial Studies, Society for Financial Studies, vol. 6(4), pages 733-64.
  7. Hendrik Bessembinder & Kathleen M. Kahle & William F. Maxwell & Danielle Xu, 2009. "Measuring Abnormal Bond Performance," Review of Financial Studies, Society for Financial Studies, vol. 22(10), pages 4219-4258, October.
  8. Jun Pan & Kenneth J. Singleton, 2008. "Default and Recovery Implicit in the Term Structure of Sovereign "CDS" Spreads," Journal of Finance, American Finance Association, vol. 63(5), pages 2345-2384, October.
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