EDHEC on CDS Speculators and Eurozone Bonds
| Apr 9th, 2012 | Filed under: Academic Research, Timely Research, Today's Post | By: cfaille |
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Dominic O’Kane, of the EDHEC Business School, has performed an analysis of the relationship between the credit default swaps market and the market for the underlying bonds, with reference specifically to the bonds issued by the Eurozone’s more credit-challenged countries.
The result is a working paper for the EDHEC-Risk Institute that is at least in part a reaction to the European Parliament’s ban on naked CDS’ in October 2011. That Parliament was clearly acting on the hypothesis that speculative trading in CDS’s in 2010-2011 had pushed bond prices down in the eurozone periphery, worsening the fiscal crises there.
EDHEC-Risk, in a news release that accompanied O’Kane’s report, expressed the view that the ban on naked CDS’s may be counterproductive; that is, it may cause harm to the banking system by “removing one sovereign risk mitigation tool.”
Causal Links and Radars
O’Kane’s study itself undermines the naked CDS ban from the other direction: not by pointing to its costs but by questioning the reality of its alleged benefits. The ban does some good only if there is a clear causal relationship between the CDS market and the referenced bonds, with the suspect activity in the former creating distortions in the latter. O’Kane cautions against accepting that causal link. His point turns on the difference between statistical (Granger) causality and physical causality.
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Author Bio:
Christopher Faille is a Jamesian pragmatist. William James has taught him, for example, that "you can say of a line that it runs east, or you can say that it runs west, and the line per se accepts both descriptions without rebelling at the inconsistency."
