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Synthetic or real? The equilibrium effects of credit default swaps on bond markets

Oehmke, Martin and Zawadowski, Adam (2015) Synthetic or real? The equilibrium effects of credit default swaps on bond markets. Review of Financial Studies, 28 (12). pp. 3303-3337. ISSN 0893-9454

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Identification Number: 10.1093/rfs/hhv047

Abstract

We provide a model of nonredundant credit default swaps (CDSs), building on the observation that CDSs have lower trading costs than bonds. CDS introduction involves a trade-off: it crowds out existing demand for the bond, but improves the bond allocation by allowing long-term investors to become levered basis traders and absorb more of the bond supply. We characterize conditions under which CDS introduction raises bond prices. The model predicts a negative CDS-bond basis, as well as turnover and price impact patterns that are consistent with empirical evidence. We also show that a ban on naked CDSs can raise borrowing costs.

Item Type: Article
Official URL: https://academic.oup.com/rfs
Additional Information: © 2015 The Authors
Divisions: Finance
Subjects: H Social Sciences > HG Finance
Sets: Departments > Finance
Date Deposited: 09 Oct 2017 13:25
Last Modified: 20 Sep 2019 02:05
URI: http://eprints.lse.ac.uk/id/eprint/84511

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