US Corporate Default Swap Valuation: The Market Liquidity Hypothesis and Autonomous Credit Risk
AbstractThis paper develops a reduced form three-factor model which includes a liquidity proxy of market conditions which is then used to provide implicit prices. The model prices are then compared with observed market prices of credit default swaps to determine if swap rates adequately reflect market risks. The findings of the analysis illustrate the importance of liquidity in the valuation process. Moreover, market liquidity, a measure of investors. willingness to commit resources in the credit default swap (CDS) market, was also found to improve the valuation of investors. autonomous credit risk. Thus a failure to include a liquidity proxy could underestimate the implied autonomous credit risk. Autonomous credit risk is defined as the fractional credit risk which does not vary with changes in market risk and liquidity conditions.
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Bibliographic InfoPaper provided by University of Connecticut, Department of Economics in its series Working papers with number 2007-08.
Length: 40 pages
Date of creation: Jan 2007
Date of revision:
Publication status: Forthcoming in The Journal of Quantitative Finance
Note: This is a preprint of an article submitted for consideration in the Journal of Quantitative finance 2007; cc Taylor and Francis; The Journal of Quantitative Finance is available online at http://journalsonline.tandf.co.uk/
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Web page: http://www.econ.uconn.edu/
More information through EDIRC
Credit Default Swaps; Market Liquidity; Bid-Ask Spreads; Autonomous Credit Risk; Risk Premium;
Other versions of this item:
- Kwamie Dunbar, 2008. "US corporate default swap valuation: the market liquidity hypothesis and autonomous credit risk," Quantitative Finance, Taylor and Francis Journals, vol. 8(3), pages 321-334.
- NEP-ALL-2007-04-21 (All new papers)
- NEP-FMK-2007-04-21 (Financial Markets)
- NEP-MST-2007-04-21 (Market Microstructure)
- NEP-RMG-2007-04-21 (Risk Management)
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