By auction at issue, and then in secondary markets. The securities would protect against default over a fixed timeframe, so overall the market would look much l

By auction at issue, and then in secondary markets. The securities would protect against default over a fixed timeframe, so overall the market would look much like the market for treasuries. But, no, a central bank wouldn't really have to price its credit derivatives correctly. That's really the whole point: if it (and the market) gets the price wrong, the central bank can print money to fix the mess, which is (a) something that a private institution like AIG cannot do, adding a significant second-order risk that such institutions fail, and (b) when the market does get it wrong and a crisis results, the central bank ends up stepping in anyway, effectively issuing insurance post facto, only nobody has paid any premium for that insurance. The trickier question is what notional value to issue. The obvious answer is that it would depend on each institution's contribution to systemic counterpart risk, but it might also make sense to leave the amounts to the discretion of central bankers: this would give them another lever of monetary policy to lean on, effectively giving them the ability to say, "No, don't worry about that bank failing. We've got you covered." (And trickier still is how to ensure that the parties that are apt to suffer losses actually hold the insurance that would protect them. Particularly if it is expensive, they might not want to, and financial institutions have long created separate legal vehicles to obscure and lop off the risks they nevertheless indirectly retain.)