Fixing the flaw in sovereign CDSs

Good fortune ensured credit default swaps (CDSs) on Greek debt paid out at a level close to the actual losses suffered by bondholders in the country’s restructuring. But the market cannot rely on luck. Darrell Duffie and Mohit Thukral propose a redesign of the CDS contract

Darrell Duffie - Stanford University

of Greek debt was a tortured, complex affair that exposed a simple flaw in credit default swap (CDS) documentation as it applies to sovereign bonds – the payout to a protection buyer is determined by the price of the deliverable debt at auction, rather than the loss suffered by bondholders. If the auction price of the bonds, for whatever reason, does not reflect those losses, neither will the payment a protection buyer receives.

Dealers have called for the market to learn lessons from the

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