The Time Varying Properties of Credit and Liquidity Components of CDS Spreads

Filippo Coro, Alfonso Dufour and Simone Varotto ()
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Filippo Coro: ICMA Centre, Henley Business School, University of Reading

ICMA Centre Discussion Papers in Finance from Henley Business School, University of Reading

Abstract: This paper investigates the role of credit and liquidity factors in explaining corporate CDS price changes during normal and crisis periods. We find that liquidity risk is more important than credit risk regardless of market conditions. Moreover, in the period prior to the recent 'Great Recession' credit risk plays no role in explaining CDS price changes. The dominance of liquidity effects casts serious doubts on the relevance of CDS price changes as an indicator of default risk dynamics. Our results show how multiple liquidity factors including firm specific and aggregate liquidity proxies as well as an asymmetric information measure are critical determinants of CDS price variations. In particular, the impact of informed traders on the CDS price increases when markets are characterised by higher uncertainty, which supports concerns of insider trading during the crisis.

Keywords: CDS; Liquidity; Credit Risk; Financial Crisis; Informed trading; Trade impact (search for similar items in EconPapers)
JEL-codes: G01 G11 G15 G32 (search for similar items in EconPapers)
Date: 2012-02
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Citations: View citations in EconPapers (2)

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