Abstract
The centralized market for the settlement of credit default swaps (CDS), which governs more than $20 trillion’s worth of outstanding CDS contracts, has been criticized for underpricing the defaulted bonds that underlie the contracts. I take a mechanism design approach to the market for the settlement of CDS contracts and characterize robust settlement mechanisms that deliver unbiased prices for the underlying assets. All robust settlement mechanisms are the payoff equivalent of a posted price mechanism. Because forced participation in the settlement mechanism is not possible, my approach requires the development of a new notion of the core of games of incomplete information. This new notion can be applied to mechanism design environments in which side trades are allowed or when joining the mechanism is a cooperative decision.
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