Will banning naked CDS impact bond prices? (Q481373)

This paper studies the impact of banning naked positions of credit default swaps on bond prices. A partial equilibrium model is used to study the impact. In particular, a partial equilibrium is established in an economy consisting of a risk-free security, a defaultable bond and a credit default swap on the bond and with multiple agents, where one of these agents is the market maker and the rest of them are investors. The investors are mean-variance-utility maximizers and the ban on naked positions of credit default swaps exhibits in a form of constraints on the investors. The optimal strategies of the investors are derived in Section 3, while the optimal decision of the market maker in equilibrium is presented in Section 4. Equilibrium market prices are obtained in Section 5, where two cases, namely the naked positions of credit default swaps are allowed and they are banned, are considered. Some numerical results for the comparative static analysis in two scenarios, namely a normal scenario and a crisis scenario, are presented in Section 6.