Title: Market Efficiency and Default Risk: Evidence of an Anomaly from the CDS and Loan CDS Markets
Abstract: We formulate a Cournot-type market equilibrium model of simultaneous trading in the CDS and Loan CDS (LCDS) markets. We use novel formulations of two-market demand functions that include trading costs and margins. The equilibrium identifies a relation between premiums, elasticities and recovery rates in both markets. The relation under perfect competition coincides with the one that prevails under no-arbitrage. The oligopoly version of the relation is consistent with observed significantly positive and persistent earnings from simulated portfolios of a large number of matured contracts in the two markets. Extensive empirical tests confirm the model’s predictions and decisively reject competing theories.
Publication Year: 2013
Publication Date: 2013-01-01
Language: en
Type: article
Indexed In: ['crossref']
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Cited By Count: 4
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