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Debt Collateralization, Structured Finance, and the CDS Basis

Author

Listed:
  • Feixue Gong

    (Massachusetts Institute of Technology)

  • Gregory Phelan

    (Williams College)

Abstract

Tranching an asset increases its basis; tranching a CDS, as occurs with the CDX index, increases the CDS basis on the underlying asset. We study how the ability to use financial contracts as collateral affects the CDS basis using a general equilibrium model with collateralized financial promises and multiple states of uncertainty. A positive basis emerges when risky assets and their derivative debt contracts can be used as collateral for financial promises. We provide an empirical test of our theory using inclusion in the CDX and find that inclusion in the CDX increases the CDS basis.

Suggested Citation

  • Feixue Gong & Gregory Phelan, 2019. "Debt Collateralization, Structured Finance, and the CDS Basis," Department of Economics Working Papers 2019-18, Department of Economics, Williams College.
    • Handle: RePEc:wil:wileco:2019-18
    Note: This is an update of WP 2016-06
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    2. Feixue Gong & Gregory Phelan, 2020. "Debt collateralization, capital structure, and maximal leverage," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 70(2), pages 579-605, September.

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    Keywords

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    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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