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Collateral Constraints, Tranching, and Price Bases

Author

Listed:
  • Feixue Gong

    (Massachusetts Institute of Technology)

  • Gregory Phelan

    (Williams College)

Abstract

Tranching an asset increases its basis; tranching a CDS, as occurs with the CDX index, increases the basis on the underlying asset. We consider a general equilibrium model with collateralized financial promises and multiple states of uncertainty to study how allowing an asset to back multiple financial contracts (i.e., tranching) affects price bases. A positive basis emerges when risky assets and their derivative contracts can be used as collateral for financial promises. We provide an empirical test of our theory using inclusion in the CDX and find that inclusion in the CDX increases the CDS basis.

Suggested Citation

  • Feixue Gong & Gregory Phelan, 2020. "Collateral Constraints, Tranching, and Price Bases," Department of Economics Working Papers 2020-03, Department of Economics, Williams College.
    • Handle: RePEc:wil:wileco:2020-03
    Note: This is an update of working paper 2019-18
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    Cited by:

    1. Broer, Tobias & Kero, Afroditi, 2021. "Collateralization and asset price bubbles when investors disagree about risk," Journal of Banking & Finance, Elsevier, vol. 128(C).

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    More about this item

    Keywords

    Collateral; securitized markets; cash-synthetic basis; credit default swaps; asset prices; credit spreads.;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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