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Liquidity Premia in CDS Markets

51 Pages Posted: 3 Aug 2017  

Christel Merlin Kuate Kamga

Goethe University Frankfurt

Christian Wilde

Goethe University Frankfurt - Department of Finance

Date Written: August 1, 2017

Abstract

We develop a state-space model to decompose bid and ask quotes of CDS into two components, fair default premium and liquidity premium. This approach gives a better estimate of the default premium than mid quotes, and it allows to disentangle and compare the liquidity premium earned by the protection buyer and the protection seller. In contrast to other studies, our model is structurally much simpler, while it also allows for correlation between liquidity and default premia, as supported by empirical evidence. The model is implemented and applied to a large data set of 118 CDS for a period ranging from 2004 to 2010. The model-generated output variables are analyzed in a difference-in-difference framework to determine how the default premium, as well as the liquidity premium of protection buyers and sellers, evolved during different periods of the financial crisis and to which extent they differ for financial institutions compared to non-financials.

Keywords: CDS, liquidity

JEL Classification: C22, G12

Suggested Citation

Kuate Kamga, Christel Merlin and Wilde, Christian, Liquidity Premia in CDS Markets (August 1, 2017). SAFE Working Paper No. 173. Available at SSRN: https://ssrn.com/abstract=3005276

Christel Merlin Kuate Kamga

Goethe University Frankfurt ( email )

Gr├╝neburgplatz 1
Frankfurt am Main, 60323
Germany

Christian Wilde (Contact Author)

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Grueneburgplatz 1
Frankfurt am Main, Hessen 60323
Germany

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