CDS Auctions and Informative Biases in CDS Recovery Rates

Gupta, Sudip; Sundaram, Rangarajan K.

doi:10.2139/ssrn.1942727

Cited by 18 publications

(21 citation statements)

References 14 publications

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“…Their empirical evaluation, however, suggests that historically, bonds have on average been underpriced by 6%. This mirrors the findings in Gupta and Sundaram (2013), although the magnitude of the underpricing is significantly smaller.…”

Section: Cds Auctionssupporting

confidence: 83%

“…Three of these are empirical (Helwege et al (2009), Coudert andGex (2010), Gupta and Sundaram (2013)), while two other studies investigate the process from a theoretical perspective (Chernov and Makarov (2012), Du and Zhu (2013)). The most complete picture to date is probably given by Gupta and Sundaram (2013), who study a total of 76 auctions over the period [2008][2009][2010]. The authors conclude that the auction prices are significantly biased relative to the pre-and post-auction bond prices and that the underpricing is on average about 20%.…”

Section: Cds Auctionsmentioning

confidence: 99%

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Credit Default Swaps: A Survey

et al. 2014

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Credit default swaps (CDS) have been growing in importance in the global financial markets. However, their role has been hotly debated, in industry and academia, particularly after the credit crisis of 2008-2009 and the European sovereign crisis of 2010-2012. We review the extant literature on CDS that has accumulated over the past two decades. We divide our survey into seven topics after providing a broad overview in the introduction. The second section traces the historical development of CDS markets and provides an introduction to CDS contract definitions and conventions. The third section discusses the pricing of CDS, from the perspective of no-arbitrage principles as well as from that of structural and reduced-form credit risk models. It also summarizes the literature on the determinants of CDS spreads, with a focus on the role of fundamental credit risk factors, liquidity and counterparty risk. The fourth section discusses how the development of the CDS market has affected the characteristics of the related bond and equity markets, with an emphasis on the closely related concepts of market efficiency, price discovery, information flow and liquidity. Attention is also paid to the CDS-bond basis, the wedge between the pricing of the CDS and its reference bond, and the mispricing between the CDS and the equity market, which leads to a discussion on capital structure arbitrage. The fifth section examines the effect of CDS trading on firms' credit and bankruptcy risk, and how it affects corporate financial policy, including bond issuance, capital structure, liquidity management, and both external and internal corporate governance. The sixth section summarizes the literature that takes into account how CDS may impact the incentives of the various agents in the economy and the associated impact on the pricing of the contracts. In particular, we examine how CDS may alter the debtor-creditor relationship. Section seven reviews the growing literature on sovereign CDS and highlights the major conceptual and contractual differences between the sovereign and corporate CDS markets. In section eight, we discuss CDS indices, especially the role of synthetic CDS index products backed by residential mortgage-backed securities during the financial crisis. We close with our suggestions for promising future research directions on CDS contracts and markets.

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Section: Cds Auctionssupporting

confidence: 83%

Section: Cds Auctionsmentioning

confidence: 99%

Credit Default Swaps: A Survey

et al. 2014

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“…Credit auctions will also enhance the information in bond markets as clarity about recovery values increases (Gupta and Sundaram (2012)). Recent global OTC derivative market reform, in particular the regulatory efforts in the US spearheaded by CFTC and SEC, recognize the important role of CDS markets vis-a-vis the bond markets and it remains to be seen how new regulations will impact the bond markets.…”

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confidence: 99%

Did CDS Trading Improve the Market for Corporate Bonds?

2011

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Did CDS Trading Improve the Market for Corporate Bonds?Financial innovation through the creation of new markets and securities impacts related markets as well, changing their efficiency, quality (pricing error) and liquidity. The credit default swap (CDS) market was undoubtedly one of the salient new markets of the past decade. In this paper we examine whether the advent of CDS trading was beneficial to the underlying secondary market for corporate bonds. We employ econometric specifications that account for information across CDS, bond, equity, and volatility markets. We also develop a novel methodology to utilize all observations in our data set even when continuous daily trading is not evidenced, because bonds trade much less frequently than equities. Using an extensive sample of CDS and bond trades over 2002-2008, we find that the advent of CDS was largely detrimental -bond markets became less efficient, evidenced no reduction in pricing errors, and experienced no improvement in liquidity. These findings are robust to various slices of the data set and specification of our tests.

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“…Exhibit 1, taken from Gupta and Sundaram [2012], illustrates using the CIT auction. For this purpose, all crossing and touching bids and offers (i.e., all bids b and offers o such that b ≥ o) are first eliminated from the submissions.…”

Section: The Auction Structurementioning

confidence: 99%

“…More generally, Gupta and Sundaram [2012] look at those auctions in which the deliverable bonds were traded actively both before and after the auction, and compare bond prices pre-and post-auction to those bond prices that resulted from the auction. For "sell" auctions (those with a second-stage NOI to sell), which constitute the vast majority of auctions in the data, they find that the auction systematically underprices the bonds relative to the market.…”

Section: The Performance Of the Auctionmentioning

confidence: 99%

CDS Auctions and Recovery Rates: An Appraisal

Sundaram

2013

JOD

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In 2005, the International Swaps and Derivatives Association (ISDA) introduced an auction mechanism to facilitate settlement following a credit event in the multi-trillion-dollar credit-default swap (CDS) market. The auction identifies a price for the defaulted instrument and this price is then used to cash-settle CDS contracts with protection sellers paying protection buyers the instrument's par valueminus the auction-identified price. Today, almost 8 years and a hundred auctions since its introduction, an appraisal of the auction mechanism and its functioning appears in order.

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CDS Auctions and Informative Biases in CDS Recovery Rates

Cited by 18 publications

References 14 publications

Credit Default Swaps: A Survey

Credit Default Swaps: A Survey

Did CDS Trading Improve the Market for Corporate Bonds?

CDS Auctions and Recovery Rates: An Appraisal

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