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The reward for trading illiquid maturities in credit default swap markets

Armen Arakelyan, Gonzalo Rubio and Pedro Serrano

International Review of Economics & Finance, 2015, vol. 39, issue C, 376-389

Abstract: This paper analyzes the risk of trading in the illiquid part of the credit default swap (CDS) term structure, especially when investors cannot unwind their positions due to exogenous liquidity shocks. To assess the size of this illiquidity premium, we construct credit-quality-sorted portfolios of CDS spreads. The illiquidity and default risk premia components are extracted from the CDS curve using a two-factor intensity model. The empirical results show a significant compensation for purchasing illiquid CDS maturities, in particular for lower credit-quality portfolios. Moreover, these illiquidity risk premia covariate significantly with the Amihud's aggregate illiquidity measure of corporate bonds.

Keywords: Credit default swaps; Illiquidity term structure; Intensity models; Default risk premium; Illiquidity risk premium (search for similar items in EconPapers)
JEL-codes: G01 G11 G15 G32 (search for similar items in EconPapers)
Date: 2015
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DOI: 10.1016/j.iref.2015.07.006

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