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Will banning naked CDS impact bond prices?

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  • 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
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    References listed on IDEAS

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    1. 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.
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    4. 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.
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    6. 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.
    7. 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.
    8. Theo Lubke & Ada Li & Darrell Duffie, 2010. "Policy perspectives on OTC derivatives market infrastructure," Staff Reports 424, Federal Reserve Bank of New York.
    9. 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.
    10. Duffie, Darrell, 1996. "Special Repo Rates," Journal of Finance, American Finance Association, vol. 51(2), pages 493-526, June.
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    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.

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    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

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