Overpricing in Emerging Market Credit-Default-Swap Contracts: Some Evidence From Recent Distress Cases

Abstract

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.Since recent debt restructurings that constitute credit events have been more frequent than outright defaults, sovereign bond prices may not collapse during distress. In this case, the likely high recovery values after restructuring suggest that the cost of credit-default-swap (CDS) contracts to the buyer (as measured by CDS spreads) may be higher than warranted. We estimate the extent of such overpricing by using the cheapest-to-deliver (CTD) bond as a proxy for the recovery-value assumption. JEL Classification Numbers: F3, F34, G15, K33, K41