IDEAS home Printed from https://ideas.repec.org/a/kap/annfin/v10y2014i3p481-508.html
   My bibliography  Save this article

Will banning naked CDS impact bond prices?

Author

Listed:
  • Agostino Capponi
  • Martin Larsson

Abstract

We develop a tractable partial equilibrium model to analyze the impact on the bond market generated by a ban on naked credit default swaps (CDS). We demonstrate that such a ban will have a negligible impact on the borrowing costs if CDS speculators are risk averse and take positions which are small relatively to the amount of debt outstanding. We find that the ban only excludes from the market moderately pessimistic investors, and induces the most pessimistic to implement their strategy on the short side of the bond market. Despite the sovereign debtor benefits from the reduced yields on the issued bonds, he will suffer from a diminished borrowing capacity after the ban. Such findings suggest that regulators should consider other measures to reduce instability arising from excessive speculation in derivatives markets. Copyright Springer-Verlag Berlin Heidelberg 2014

Suggested Citation

  • Agostino Capponi & Martin Larsson, 2014. "Will banning naked CDS impact bond prices?," Annals of Finance, Springer, vol. 10(3), pages 481-508, August.
    • Handle: RePEc:kap:annfin:v:10:y:2014:i:3:p:481-508
    DOI: 10.1007/s10436-013-0243-4
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1007/s10436-013-0243-4
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1007/s10436-013-0243-4?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Dion Bongaerts & Frank De Jong & Joost Driessen, 2011. "Derivative Pricing with Liquidity Risk: Theory and Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, vol. 66(1), pages 203-240, February.
    2. Duffie, D., 2010. "Is there a case for banning short speculation in sovereign bond markets?," Financial Stability Review, Banque de France, issue 14, pages 55-59, July.
    3. Michael B. Gordy & SØren Willemann, 2012. "Constant Proportion Debt Obligations: A Postmortem Analysis of Rating Models," Management Science, INFORMS, vol. 58(3), pages 476-492, March.
    4. Fontana, Alessandro & Scheicher, Martin, 2016. "An analysis of euro area sovereign CDS and their relation with government bonds," Journal of Banking & Finance, Elsevier, vol. 62(C), pages 126-140.
    5. Theo Lubke & Ada Li & Darrell Duffie, 2010. "Policy perspectives on OTC derivatives market infrastructure," Staff Reports 424, Federal Reserve Bank of New York.
    6. Patrick Bolton & Martin Oehmke, 2011. "Credit Default Swaps and the Empty Creditor Problem," The Review of Financial Studies, Society for Financial Studies, vol. 24(8), pages 2617-2655.
    7. Duffie, Darrell, 1996. "Special Repo Rates," Journal of Finance, American Finance Association, vol. 51(2), pages 493-526, June.
    8. Ashcraft, Adam B. & Santos, João A.C., 2009. "Has the CDS market lowered the cost of corporate debt?," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 514-523, May.
    9. Boone, L. & Fransolet, L. & Willemann, S., 2010. "Euro public debt and the markets: sovereign fundamentals and CDS market dynamics," Financial Stability Review, Banque de France, issue 14, pages 19-26, July.
    10. Marti G. Subrahmanyam & Dragon Yongjun Tang & Sarah Qian Wang, 2012. "Does the Tail Wag the Dog? The Effect of Credit Default Swaps on Credit Risk," Working Papers 292012, Hong Kong Institute for Monetary Research.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Kliber Agata, 2016. "Impact Of The Ban On Uncovered SCDS Trade On the Interdependencies Between The CDS Market And Other Sectors Of Financial Markets. The Case Of Safe And Developed Versus Risky And Developing European Ma," Comparative Economic Research, Sciendo, vol. 19(1), pages 77-99, March.
    2. Saker Sabkha & Christian Peretti & Dorra Hmaied, 2019. "On the informational market efficiency of the worldwide sovereign credit default swaps," Journal of Asset Management, Palgrave Macmillan, vol. 20(7), pages 581-608, December.
    3. Gyntelberg, Jacob & Hördahl, Peter & Ters, Kristyna & Urban, Jörg, 2018. "Price discovery in euro area sovereign credit markets and the ban on naked CDS," Journal of Banking & Finance, Elsevier, vol. 96(C), pages 106-125.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Patrick Augustin, 2012. "Sovereign Credit Default Swap Premia," Working Papers 12-10, New York University, Leonard N. Stern School of Business, Department of Economics.
    2. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    3. Ismailescu, Iuliana & Phillips, Blake, 2015. "Credit default swaps and the market for sovereign debt," Journal of Banking & Finance, Elsevier, vol. 52(C), pages 43-61.
    4. Juan Ignacio Pe~na, 2019. "Credit Cycles, Securitization, and Credit Default Swaps," Papers 1901.00177, arXiv.org.
    5. Norden, Lars, 2017. "Information in CDS spreads," Journal of Banking & Finance, Elsevier, vol. 75(C), pages 118-135.
    6. Juliana Salomao, 2015. "Sovereign Debt Renegotiation and Credit Default Swaps," 2015 Meeting Papers 826, Society for Economic Dynamics.
    7. Hasan Murat Ertugrul & Huseyin Ozturk, 2013. "The Drivers of Credit Default Swap Prices: Evidence from Selected Emerging Market Countries," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 49(S5), pages 228-249, November.
    8. Arnold, M., 2017. "The impact of central clearing on banks’ lending discipline," Journal of Financial Markets, Elsevier, vol. 36(C), pages 91-114.
    9. Qiu, Jiaping & Yu, Fan, 2012. "Endogenous liquidity in credit derivatives," Journal of Financial Economics, Elsevier, vol. 103(3), pages 611-631.
    10. Oehmke, Martin & Zawadowski, Adam, 2015. "Synthetic or real? The equilibrium effects of credit default swaps on bond markets," LSE Research Online Documents on Economics 84511, London School of Economics and Political Science, LSE Library.
    11. Jung Koo Kang & Christopher D. Williams & Regina Wittenberg-Moerman, 2021. "CDS trading and nonrelationship lending dynamics," Review of Accounting Studies, Springer, vol. 26(1), pages 258-292, March.
    12. Hwang Hee Lee & Frederick Dongchuhl Oh, 2022. "The role of credit default swaps in determining corporate payout policy," Financial Management, Financial Management Association International, vol. 51(2), pages 635-661, June.
    13. Czech, Robert, 2021. "Credit default swaps and corporate bond trading," Journal of Financial Intermediation, Elsevier, vol. 48(C).
    14. Blanco, Iván & García, Sergio J., 2021. "Options trading and the cost of debt," Journal of Corporate Finance, Elsevier, vol. 69(C).
    15. Gündüz, Yalin & Nasev, Julia & Trapp, Monika, 2012. "The price impact of CDS trading," CFR Working Papers 12-12, University of Cologne, Centre for Financial Research (CFR).
    16. Taurai Muvunza & Yong Jiang, 2023. "Determinants and hedging effectiveness of China's sovereign credit default swaps," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(2), pages 2074-2087, April.
    17. Gunther Capelle-Blancard, 2010. "Are derivatives dangerous?," Post-Print halshs-00605908, HAL.
    18. Martin, Xiumin & Roychowdhury, Sugata, 2015. "Do financial market developments influence accounting practices? Credit default swaps and borrowers׳ reporting conservatism," Journal of Accounting and Economics, Elsevier, vol. 59(1), pages 80-104.
    19. Arping, Stefan, 2014. "Credit protection and lending relationships," Journal of Financial Stability, Elsevier, vol. 10(C), pages 7-19.
    20. Wang, Xinjie & Wu, Yangru & Yan, Hongjun & Zhong, Zhaodong (Ken), 2021. "Funding liquidity shocks in a quasi-experiment: Evidence from the CDS Big Bang," Journal of Financial Economics, Elsevier, vol. 139(2), pages 545-560.

    More about this item

    Keywords

    Partial equilibrium; Sovereign debt; Credit default swaps; Trading restrictions; D5; E4; E5;
    All these keywords.

    JEL classification:

    • D5 - Microeconomics - - General Equilibrium and Disequilibrium
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:kap:annfin:v:10:y:2014:i:3:p:481-508. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.