Endogenous Liquidity in Credit Derivatives
McMaster University - Michael G. DeGroote School of Business
Claremont McKenna College - Robert Day School of Economics and Finance
March 14, 2011
AFA 2012 Chicago Meetings Paper
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.
Number of Pages in PDF File: 47
Date posted: March 15, 2011