CDS Credit Event Auctions

Abstract

two others who wished to remain anonymous. A very special thanks to Joel Hasbrouck for several valuable discussions concerning the analysis in this paper and especially for suggesting procedures to overcome data deficiencies and anomalies; thanks also to Ravi Jagannathan for his comments and suggestions. Much useful input was also provided by participants at conferences and seminars where earlier versions of this paper were presented including the Nasdaq OMX Derivatives AbstractCredit-event auctions were introduced in 2005 to facilitate cash settlement in the credit default swap market following a credit event. They have a novel two-stage structure that makes them distinct from other auction forms. This paper studies outcomes in credit-event auctions over the period 2008-10.Our analysis is in three parts. In the first part, we look at the efficacy of price discovery in the auction. We find that the auction price has a significant bias relative to the pre-and post-auction market prices for the same instruments, and that volatility of market prices often increases after the auction; nonetheless, we find that information generated in the auction is very valuable for post-auction market price formation. In the second part of the analysis, we look at behavior within and across auctions and the factors that influence it. We find, among other things, that "winner's curse" concerns play a central role, affecting liquidity provision in the auction, the pricing bias, and bidders' within-auction updating of their private information. In the final part of the paper, under some simplifying assumptions, we carry out a structural estimation to recover the underlying distribution of signals. Using these estimates, we find that the alternative auction formats could reduce the amount of bias in the auction final price.