CDS Credit-Event Auctions

Credit-event auctions were introduced in 2005 to facilitate cash settlement in the credit default swap market following a credit event. The auctions have a novel and complex structure that makes them distinct from other auction forms. This paper studies outcomes in credit-event auctions over the period 2008-10. We find that the auction price has a significant bias relative to the preand post-auction market prices for the same instruments, and that volatility of market prices often increases after the auction; nonetheless, the auction generates valuable information for post-auction market price formation. We find strong evidence that “winner’s curse” concerns and strategic considerations significantly affect liquidity provision in the auction. Bidders’ updating of their private information based on the public information revealed during the auction is significantly affected by the possibility of winner’s curse. Lastly, under assumptions that enable us to focus solely on the second stage of the auction, we carry out a structural estimation to recover the underlying distribution of signals. Using these estimates, we find that the alternative auction formats could reduce the amount of bias in the auction final price.