This paper documents an increase in the comovement between credit default swap (CDS) spread changes during the 2007–2009 crisis and investigates the source of that increase. One possible explanation is that comovement increased because fundamental values became more correlated. However, I find that changes in fundamentals account for only 23% of the increase in covariance. The remaining increase is attributed to changes in liquidity and the market price of default risk. In contrast, counterparty risk played an insignificant role. Although both contributed, the increase in covariance was driven more by variation in exposures than factor variance–covariance

Using novel position and trading data for single-name corporate credit default swaps (CDSs), we provide evidence that CDS markets emerge as “alternative trading venues” serving a standardization and liquidity role. CDS positions and trading volume are larger for firms with bonds fragmented into many separate issues and with heterogeneous contractual terms. Whereas hedging motives are associated with trading volume in the bond and CDS markets, speculative trading concentrates in the CDS. Cross-market arbitrage links the CDS and bond market via the basis trade, compressing the negative CDS-bond basis and reducing price impact in the bond market

We study how crises affect Central Clearing Counterparties (CCPs). We focus on a large and safe segment of the CCP-cleared repo market during the Eurozone sovereign debt crisis. We develop a simple model to infer CCP stress, which is measured as repo rates’ sensitivity to sovereign credit default swaps (CDS) spreads and jointly captures (1) the effectiveness of haircut policies, (2) CCP-member default risk (conditional on sovereign default), and (3) CCP default risk (conditional on both sovereign and CCP-member default). During 2011, repo rates strongly respond to sovereign risk, particularly for Greece, Italy, Ireland, Portugal and Spain (GIIPS): Repo investors behaved as if the conditional probability of CCP default was substantial

We study the design of credit default swaps (CDS) auctions, which determine the payments by CDS sellers to CDS buyers following defaults of bonds. Using a simple model, we find that the current design of CDS auctions leads to biased prices and inefficient allocations. This is because various restrictions imposed in CDS auctions prevent certain investors from participating in the price discovery and allocation process. The imposition of a price cap or floor also gives dealers large influence on the final auction price. We propose an alternative double auction design that delivers more efficient price discovery and allocations