Endogenous Liquidity in Credit Derivatives
47 Pages Posted: 15 Mar 2011
Date Written: March 14, 2011
We study the determination of liquidity provision as measured by the number of distinct dealers providing quotes in the single-name credit default swap (CDS) market. Cross-sectionally, liquidity is concentrated among large obligors and those near the investment-grade/speculative-grade cutoff. Consistent with endogenous liquidity provision by informed financial institutions, more liquidity is associated with obligors for which there is a greater information flow from the CDS market to the stock market ahead of major credit events. Furthermore, the level of information heterogeneity plays a prominent role in how liquidity provision responds to transaction demand and how liquidity is priced into the CDS premium.
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