Hedging Credit: Equity Liquidity Matters
13 Pages Posted: 11 Nov 2007 Last revised: 25 Sep 2015
Date Written: October 9, 2007
Credit default swap (CDS) spreads are directly related to equity market liquidity in the Merton (1974) model via hedging. This relationship is monotone increasing when credit quality worsens. Empirical tests confirm this relationship. We theorize and confirm this new channel by means of which liquidity costs are embedded in CDS spreads.
Keywords: Credit Default Swaps, Liquidity
JEL Classification: G0, G1
Suggested Citation: Suggested Citation