Market Signals and the Cost of Credit Risk Protection: An Analysis of CDS Settlement Auctions
IMF Working Papers, December 24, 2014
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- Market Signals and the Cost of Credit Risk Protection: An Analysis of CDS Settlement Auctions
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Bibliographic details
- Authors: Luisa Zanforlin, Nobuyuki Kanazawa
- Published: December 24, 2014
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781498389471.001
Summary and research question
- Authors: Luisa Zanforlin, Nobuyuki Kanazawa
- Date: December 24, 2014
- Pages: 32
- Series: Working Paper No. 2014/239
- Issue: 239
- Volume: 2014
- DOI: https://doi.org/10.5089/9781498389471.001
- ISBN: 9781498389471
- ISSN: 1018-5941
- Research focus: The link between the probability of default implied by Credit Default Swaps (CDS) spreads and the final prices of defaulted bonds as established at CDS settlement auctions.
Key findings
- Post-default recovery rates implied by observed CDS spreads indicate markets were often “surprised” by the credit event.
- Prices of bonds deliverable at CDS settlement auctions imply probabilities of default that are systematically different than default probabilities estimated prior to default using standard methodologies.
- The discrepancy between actual and theoretical CDS spreads is:
- Significantly associated with CDS market microstructure at the time of the settlement auction.
- Significantly associated with the general macroeconomic background.
- The authors discuss the potential for strategic bidding behavior at CDS settlement auctions.
Analysis and implications for CDS pricing models
- The observed systematic differences between auction-determined bond prices (and implied default probabilities) and standard ex-ante default estimates have implications for CDS pricing models.
- Market surprises (as inferred from post-default recovery rates relative to pre-default spreads) challenge models that assume pre-default CDS spreads fully reflect default likelihoods and recoveries.
- The association of spread discrepancies with market microstructure and macroeconomic conditions suggests models should account for auction mechanics and macroeconomic state when relating CDS spreads to default probabilities.
Topics and keywords covered
- Subject areas: Asset and liability management, Asset prices, Asset valuation, Bonds, Credit, Credit default swap, Currencies, Financial institutions, Money, Prices
- Keywords: Asset prices, Asset valuation, Bonds, CDS buyer, CDS contract, CDS market, CDS seller, Credit, Credit default swap, Credit Default Swaps, credit event, default probability, Derivative Markets, Market signals, settlement auction, WP
Publication and citation details
- Citation format shown (Chicago): Luisa Zanforlin, and Nobuyuki Kanazawa. "Market Signals and the Cost of Credit Risk Protection: An Analysis of CDS Settlement Auctions", IMF Working Papers 2014, 239 (2014), accessed 9/9/2026, https://doi.org/10.5089/9781498389471.001
IMF Working Paper No. 2014/239, December 24, 2014 — Luisa Zanforlin and Nobuyuki Kanazawa
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