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Abstract
This article studies bidding behavior in the novel and complex auctions that, since 2005, have determined recovery rates in the multi-trillion dollar credit default swap (CDS) market. We find that bids are substantially influenced by inventory effects (bidders’ CDS positions entering the auction), market illiquidity, and “winners curse” considerations. The economically and statistically significant extent of “bid-shading” induced by these factors explains why auction prices deviate significantly (on average >16%) from pre- and post-auction market prices for the same instruments even while auction-generated information is significantly informative for post-auction market price formation.
TOPICS: Credit default swaps, statistical methods
Footnotes
Our thanks to many market participants for conversations about the mechanics and working of credit event auctions, particularly Hugo Barth, Karel Engelen, Bjorn Flesaker, David Mengle, Arvind Rajan, and two others who wished to remain anonymous. A very special thanks to Joel Hasbrouck for several valuable discussions concerning the analysis in this article and especially for suggesting procedures to overcome data deficiencies and anomalies; and to David McAdams for his comments in his role as discussant of the article. Much useful input was also provided by participants in conferences and seminars in which earlier versions of this article were presented, including seminars at Columbia Business School, Indian School of Business, Kellogg School–Northwestern, National University of Singapore, Price College of Business–U of Oklahoma, Singapore Management University, the Commodity Futures Trading Commission, and Standard & Poor’s; and conferences at the Nasdaq-OMX Research Day at NYU–Stern, the Moody’s-LBS Credit Risk Conference, the Mont Tremblant Risk Management Conference, and the Securities Markets and Auctions Conference at the Kellogg School–Northwestern.
To order reprints of this article, please contact Dewey Palmieri at dpalmieri{at}iijournals.com or 212-224-3675.
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