Naked CDS Bans and the Bond Market: Empirical Evidence

Batchimeg Sambalaibat
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Batchimeg Sambalaibat: Princeton University

Working Papers from Princeton University. Economics Department.

Abstract: During the 2010-2012 sovereign debt crisis in Europe, policy makers responded to the controversy surrounding CDS by implementing a series of policies that banned naked CDS trading. These policies serve as quasi-natural experiments that allow us to empirically identify the effect of naked CDS trading on the underlying bonds. We document that a temporary CDS ban increased bond market liquidity while a permanent ban decreased bond market liquidity. Thus, permanent versus temporary bans had opposite effects. An important policy implication is that permanently banning naked CDS trading adversely affected bond market liquidity, depressed bond prices, and thereby increased sovereign’s borrowing cost exactly when governments were trying to avert a liquidity dry-up and credit risk spiral.

Keywords: Europe; Debt; CDS trading; Bond Market; Sovereign Debt (search for similar items in EconPapers)
JEL-codes: F34 H63 (search for similar items in EconPapers)
Date: 2019-09
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