Credit Default Swaps, Fire-Sale Risk, and the Liquidity Provision in the Bond Market

Massimo Massa and Lei Zhang

Journal of Financial and Quantitative Analysis, 2024, vol. 59, issue 4, 1963-1996

Abstract: We study the effect of credit default swaps (CDSs) on the bond market. Using a comprehensive sample of U.S. corporate bonds, we document that the presence of CDSs significantly increases bond liquidity and reduces yield spreads for investment grade bonds. We show that CDSs influence the bond market by lowering the impact of fire sales of institutional bondholders and facilitating inventory management for bond dealers who absorb fire sale shocks. However, the liquidity provision role of CDSs gets weakened after the CDS Big Bang in 2009, potentially because of the requirement of large upfront payments.

Date: 2024
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