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

Oehmke, Martin ORCID: 0000-0001-9902-0711 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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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
Date Deposited:	09 Oct 2017 13:25
Last Modified:	24 Apr 2024 22:42
URI:	http://eprints.lse.ac.uk/id/eprint/84511

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