Bond Volatility and CDS Auctions

Abstract

We document a higher bond return volatility around the time of default for bonds included in CDS auctions (especially cheapest-to-deliver bonds) versus those that are not, while controlling for firm fundamentals and bond illiquidity. This finding does not extend to time periods far ahead of default, and there is no significant difference between the idiosyncratic stock return volatility of CDS firms and non-CDS firms around the time of default. These results are more consistent with CDS buyers and sellers manipulating bond prices to achieve favorable CDS auction outcomes, rather than a spillover of price discovery by CDS traders into the stock and bond markets.