The use of credit default swaps by bond mutual funds: Liquidity provision and counterparty risk

George Aragon, Lei Li, Jun QJ Qian

Research output: Contribution to journalArticle

Abstract

Corporate bond mutual funds increased their selling of credit protection in the credit default swaps (CDS) market during the 2007–2008 financial crisis. This trading activity was primarily in multi-name CDS, greater among larger and established funds, and directed toward counterparty dealers in financial distress. Funds that sold credit protection during the crisis experienced greater credit market risk and superior post-crisis performance, consistent with higher expected returns from liquidity provision. Funds using Lehman Brothers as a counterparty experienced abnormal outflows and returns of –2% immediately following Lehman's bankruptcy, suggesting that funds’ opportunistic trading in CDS exposed investors to counterparty risk.

Original languageEnglish (US)
JournalJournal of Financial Economics
DOIs
StateAccepted/In press - Jan 1 2018

Fingerprint

Counterparty risk
Mutual funds
Liquidity provision
Credit default swaps
Credit
Investors
Bankruptcy
Expected returns
Market risk
Credit markets
Financial distress
Financial crisis
Dealers
Corporate bonds
Trading activity

Keywords

  • Bond funds
  • Counterparty risk
  • Credit default swaps
  • Crisis
  • Liquidity provision

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

Cite this

The use of credit default swaps by bond mutual funds : Liquidity provision and counterparty risk. / Aragon, George; Li, Lei; Qian, Jun QJ.

In: Journal of Financial Economics, 01.01.2018.

Research output: Contribution to journalArticle

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