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The Credit Default Swap Market and the Settlement of Large Defaults

Author

Listed:
  • Virginie Coudert
  • Mathieu Gex
Abstract
The huge positions on the credit default swaps (CDS) have raised concerns about the ability of the market to settle major entities’ defaults. The near-failure of AIG and the bankruptcy of Lehman Brothers in 2008 have revealed the exposure of CDS’s buyers to counterparty risk and hence highlighted the necessity of organizing the market, which triggered a large reform process. First we analyse the vulnerabilities of the market at the bursting of this crisis. Second, we unravel the auction process implemented to settle defaults, the strategies of buyers and sellers and the links with the bond market. We then study the way it worked for key defaults, such as Lehman Brothers, Washington Mutual, CIT and Thomson, as well as for the Government Sponsored Enterprises, which reveals some oddities in the final prices. Third, we discuss the ongoing reforms aimed at strengthening the market resilience.

Suggested Citation

  • Virginie Coudert & Mathieu Gex, 2010. "The Credit Default Swap Market and the Settlement of Large Defaults," International Economics, CEPII research center, issue 123, pages 91-120.
    • Handle: RePEc:cii:cepiie:2010-q3-123-5
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    References listed on IDEAS

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    1. Didier Cossin & Tomas Hricko & Daniel Aunon-Nerin & Zhijiang Huang, 2002. "Exploring for the Determinants of Credit Risk in Credit Default Swap Transaction Data: Is Fixed-Income Markets’ Information Suffcient to Evaluate Credit Risk?," FAME Research Paper Series rp65, International Center for Financial Asset Management and Engineering.
    2. Eichengreen, Barry & Mody, Ashoka & Nedeljkovic, Milan & Sarno, Lucio, 2012. "How the Subprime Crisis went global: Evidence from bank credit default swap spreads," Journal of International Money and Finance, Elsevier, vol. 31(5), pages 1299-1318.
    3. Jan De Wit, 2006. "Exploring the CDS-Bond Basis," Working Paper Research 104, National Bank of Belgium.
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    Cited by:

    1. Anouk Levels & René de Sousa van Stralen & Sînziana Kroon Petrescu & Iman van Lelyveld, 2018. "CDS market structure and risk flows: the Dutch case," DNB Working Papers 592, Netherlands Central Bank, Research Department.
    2. Dimpfl Thomas & Peter Franziska Julia, 2013. "Using transfer entropy to measure information flows between financial markets," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 17(1), pages 85-102, February.
    3. Christian Gouriéroux & Alain Monfort & Sarah Mouabbi & Jean-Paul Renne, 2021. "Disastrous Defaults [Risk premia and term premia in general equilibrium]," Review of Finance, European Finance Association, vol. 25(6), pages 1727-1772.
    4. Erica Paulos & Bruno Sultanum & Elliot Tobin, 2019. "CDS Auctions: An Overview," Economic Quarterly, Federal Reserve Bank of Richmond, issue 2Q, pages 105-132.
    5. Mikhail Chernov & Alexander S. Gorbenko & Igor Makarov, 2013. "CDS Auctions," The Review of Financial Studies, Society for Financial Studies, vol. 26(3), pages 768-805.
    6. Coudert, V. & Gex, M., 2013. "Why the Greek CDS settlement did not lead to the feared meltdown," Financial Stability Review, Banque de France, issue 17, pages 135-150, April.
    7. repec:hum:wpaper:sfb649dp2012-051 is not listed on IDEAS
    8. Ma, Jason Z. & Deng, Xiang & Ho, Kung-Cheng & Tsai, Sang-Bing, 2018. "Regime-switching determinants of emerging markets sovereign credit risk swaps spread," Economics Discussion Papers 2018-52, Kiel Institute for the World Economy (IfW Kiel).
    9. Vuillemey, Guillaume & Peltonen, Tuomas A., 2015. "Disentangling the bond–CDS nexus: A stress test model of the CDS market," Economic Modelling, Elsevier, vol. 49(C), pages 32-45.
    10. 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.
    11. Kitty Moloney & Oisin Kenny & Neill Killeen, 2016. "Network analysis using EMIR credit default swap data: micro-level evidence from Irish-domiciled special purpose vehicles (SPVs)," IFC Bulletins chapters, in: Bank for International Settlements (ed.), Combining micro and macro data for financial stability analysis, volume 41, Bank for International Settlements.
    12. Agata Kliber & Barbara Bedowska-Sojka, 2013. "Economic Situation of the Country or Risk in the World Financial Market? The Dynamics of Polish Sovereign Credit Default Swap Spreads," Dynamic Econometric Models, Uniwersytet Mikolaja Kopernika, vol. 13, pages 87-106.
    13. Lawrence Jia & Bruno Sultanum & Elliot Tobin, 2020. "Sovereign CDS Market: The Role of Dealers in Credit Events," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 3, pages 97-113.
    14. Alessandro Andreoli & Luca Vincenzo Ballestra & Graziella Pacelli, 2018. "Pricing Credit Default Swaps Under Multifactor Reduced-Form Models: A Differential Quadrature Approach," Computational Economics, Springer;Society for Computational Economics, vol. 51(3), pages 379-406, March.
    15. Bratis, Theodoros & Laopodis, Nikiforos T. & Kouretas, Georgios P., 2020. "Systemic risk and financial stability dynamics during the Eurozone debt crisis," Journal of Financial Stability, Elsevier, vol. 47(C).

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    More about this item

    Keywords

    Credit derivatives; Bankruptcy; Credit default Swap; Auction;
    All these keywords.

    JEL classification:

    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • G01 - Financial Economics - - General - - - Financial Crises
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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