Liquidity Component In The Bid-Ask Spread Of Credit Default Swaps

The pace at which the credit default swaps (CDS) has been growing since its inception topped all projections. Despite the rapid growth, there is still room for enhancement of liquidity in the CDS market, which is probably due to the high entry obstacle of CDS market. Information asymmetry is another concern of investors in CDS market, however, some literature addressed that information asymmetry may not inversely affect the CDS market as serious as regarded. Bid-ask spread is commonly used as a proxy of liquidity. The study aim at the liquidity component in the CDS bid-ask spread. The study empirically confirms that CDS bid-ask spread has explanatory power to CDS premium. Using bond age, bond amount, bond time-to-maturity, proportion of zero returns, and Amihud illiquid measure as the liquidity measures of bond, we then explore the relationships between the liquidity of CDS and that of bonds. Implementing cross-sectional regression method to the largest sample, we further confirm that bond market and CDS market are closely correlated. All in all, there is negative relationship between the liquidity of CDS and that of bonds. However, this relationship is nonlinear. It will change with the rating of the underlying. We firstly implement Zero% and Amihud Illiquidity measure, though the empirical results to these variables are not significant. It may be due to the impact of asymmetric information or these measures themselves. It is one of the further research interests.