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Role of Credit Default Swap in Bubbles and Crashes

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  • Hitoshi Matsushima

    (The University of Tokyo)

Abstract

We formulate strategic aspects of speculative arbitrageurs in a stock market as a generalization of timing game with behavioral types explored by Matsushima (2013b). A company raises huge funds during the bubble driven by positive feedback traders’ euphoria by issuing shares in a socially harmful manner. The arbitrageurs borrow money from positive feedback traders under a regulation on leverage ratio and purchase credit default swaps defined as bubble-contingent claim from them. We demonstrate a theoretical ground for considering the availability of credit default swap associated with a high leverage ratio as a powerful policy method to deter harmful bubbles.

Suggested Citation

  • Hitoshi Matsushima, 2013. "Role of Credit Default Swap in Bubbles and Crashes," CARF F-Series CARF-F-331, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    • Handle: RePEc:cfi:fseres:cf331
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    References listed on IDEAS

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