Collateral Constraints, Tranching, and Price Bases

Feixue Gong and Gregory Phelan
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Feixue Gong: Massachusetts Institute of Technology

No 2021-07, Department of Economics Working Papers from Department of Economics, Williams College

Abstract: We consider a multi-state, general-equilibrium model with collateralized financial promises to study how allowing an asset to back multiple financial contracts (i.e., tranching) affects price bases. A basis emerges when one asset can be tranched to issue more derivative securities than can be backed by another asset. A positive basis emerges when derivative contracts backed by an asset can be used as collateral to issue additional financial promises. Tranching a CDS, as occurs with the CDX index, increases the basis on the underlying asset. Our theory correctly predicts that inclusion in the CDX index increases the underlying CDS basis.

Keywords: Collateral; Securitized markets; cash-synthetic basis; credit default swaps; asset prices; credit spreads (search for similar items in EconPapers)
JEL-codes: D52 D53 G11 G12 (search for similar items in EconPapers)
Pages: 40
Date: 2021-04-06
Note: This is an update of working paper 2020-03
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Related works:
Journal Article: Collateral constraints, tranching, and price bases (2023)
Working Paper: Collateral Constraints, Tranching, and Price Bases (2020)
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