The reward for trading illiquid maturities in credit default swap markets Articles uri icon

publication date

  • September 2015

start page

  • 376

end page

  • 389

volume

  • 39

International Standard Serial Number (ISSN)

  • 1059-0560

Electronic International Standard Serial Number (EISSN)

  • 1873-8036

abstract

  • This paper analyzes the risk of trading in the illiquid part of the credit default swap (CDS) term structure, especially when investors cannot unwind their positions due to exogenous liquidity shocks. To assess the size of this illiquidity premium, we construct credit-quality-sorted portfolios of CDS spreads. The illiquidity and default risk premia components are extracted from the CDS curve using a two-factor intensity model. The empirical results show a significant compensation for purchasing illiquid CDS maturities, in particular for lower credit-quality portfolios. Moreover, these illiquidity risk premia covariate significantly with the Amihud's aggregate illiquidity measure of corporate bonds. (C) 2015 Elsevier Inc. All rights reserved.

keywords

  • liquidity risk; corporate-bonds; term structure; sovereign; returns; spreads; price