Liquidity tail risk and credit default swap spreads

Felix Irresberger, Gregor N.F. Weiß, Janet Gabrysch and Sandra Gabrysch

European Journal of Operational Research, 2018, vol. 269, issue 3, 1137-1153

Abstract: We show that liquidity tail risk in credit default swap (CDS) spreads is time-varying and explains variation in CDS spreads. We capture the liquidity tail risk of a CDS contract written on a firm by estimating the tail dependence, i.e., the asymptotic probability of a joint surge in the bid-ask spread of the firm’s CDS and the illiquidity of a CDS market index. Our results show that protection sellers earn a statistically and economically significant premium for bearing the risk of joint extreme downwards movements in the liquidity of individual CDS contracts and the CDS market. This effect holds in various robustness checks such as instrumental variable regressions and alternative liquidity measures and is particularly pronounced during the financial crisis.

Keywords: Finance; Credit default swaps; Liquidity risk; Copula; Liquidity tail beta, (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:269:y:2018:i:3:p:1137-1153

DOI: 10.1016/j.ejor.2018.02.030

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