Abstract (may include machine translation)
We provide a model of nonredundant credit default swaps (CDSs), building on the observation that CDSs have lower trading costs than bonds. CDS introduction involves a trade-off: it crowds out existing demand for the bond, but improves the bond allocation by allowing long-term investors to become levered basis traders and absorb more of the bond supply. We characterize conditions under which CDS introduction raises bond prices. The model predicts a negative CDS-bond basis, as well as turnover and price impact patterns that are consistent with empirical evidence. We also show that a ban on naked CDSs can raise borrowing costs.
Original language | English |
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Pages (from-to) | 3303-3337 |
Number of pages | 35 |
Journal | Review of Financial Studies |
Volume | 28 |
Issue number | 12 |
DOIs | |
State | Published - 1 Dec 2015 |
Externally published | Yes |