The Anatomy of the CDS Market
Authors: Martin Oehmke and Adam Zawadowski
Using novel position data for single-name credit default swaps (CDS), this paper investigates the determinants of the amount of credit protection bought (or equivalently sold) in the CDS market. Our results support the view of CDS markets as `alternative trading venues’ that are used by investors for both hedging and speculation. CDS markets are more likely to emerge and more heavily used when the bonds of the underlying firm are fragmented and hard to trade. CDS positions are increasing in insurable interest (a proxy for hedging needs) and disagreement (a proxy for speculation). These effects are stronger when the underlying bond is hard to trade. We also find that firms which have a more negative CDS-bond basis (i.e., the bond is undervalued relative to the CDS) have more CDS outstanding, suggestive of arbitrage activity.