SyntheticorReal?TheEquilibriumEffectsofCreditDefaultSwapsonBondMarkets∗MartinOehmke†ColumbiaUniversityAdamZawadowski‡BostonUniversityJune29,2014AbstractWeprovideamodelofnon-redundantcreditdefaultswaps(CDSs),buildingontheobservationthatCDSsaremoreliquidthanbonds.CDSintroductioninvolvesatrade-off:Itcrowdsoutdemandforthebond,butimprovesthebondallocationbecauseitallowslong-terminvestorstobecomeleveredbasistraders.CDSintroductionraisesbondpricesonlywhenthereisasignificantliquiditydifferencebetweenbondandCDS(bothacrossandwithinfirms).OurframeworkpredictsanegativeCDS-bondbasis,turnoverandpriceimpactpatternsthatareconsistentwithempiricalevidence,andshowsthatab...
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