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Credit and liquidity components of corporate CDS spreads

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  • Corò, Filippo
  • Dufour, Alfonso
  • Varotto, Simone

Abstract

This paper investigates the role of credit and liquidity factors in explaining corporate CDS price changes during normal and crisis periods. We find that liquidity risk is more important than firm-specific credit risk regardless of market conditions. Moreover, in the period prior to the recent “Great Recession” credit risk plays no role in explaining CDS price changes. The dominance of liquidity effects casts serious doubts on the relevance of CDS price changes as an indicator of default risk dynamics. Our results show how multiple liquidity factors including firm specific and aggregate liquidity proxies as well as an asymmetric information measure are critical determinants of CDS price variations. In particular, the impact of informed traders on the CDS price increases when markets are characterised by higher uncertainty, which supports concerns of insider trading during the crisis.

Suggested Citation

  • Corò, Filippo & Dufour, Alfonso & Varotto, Simone, 2013. "Credit and liquidity components of corporate CDS spreads," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5511-5525.
  • Handle: RePEc:eee:jbfina:v:37:y:2013:i:12:p:5511-5525 DOI: 10.1016/j.jbankfin.2013.07.010
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    Citations

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    Cited by:

    1. Zhijian (James) Huang & Yuchen Luo, 2016. "Revisiting Structural Modeling of Credit Risk—Evidence from the Credit Default Swap (CDS) Market," Journal of Risk and Financial Management, MDPI, Open Access Journal, vol. 9(2), pages 1-20, May.
    2. repec:eee:ecolet:v:161:y:2017:i:c:p:10-14 is not listed on IDEAS
    3. repec:kap:rqfnac:v:49:y:2017:i:3:d:10.1007_s11156-016-0609-6 is not listed on IDEAS
    4. Dufour, Alfonso & Stancu, Andrei & Varotto, Simone, 2017. "The equity-like behaviour of sovereign bonds," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 48(C), pages 25-46.
    5. repec:gam:jjrfmx:v:9:y:2016:i:2:p:3:d:69765 is not listed on IDEAS
    6. Christian Meine & Hendrik Supper & Gregor Weiß, 2015. "Do CDS spreads move with commonality in liquidity?," Review of Derivatives Research, Springer, vol. 18(3), pages 225-261, October.
    7. repec:eee:intfin:v:48:y:2017:i:c:p:135-145 is not listed on IDEAS
    8. Thomas Dimpfl & Franziska J. Peter, 2015. "Price discovery in the markets for credit risk: A Markov switching approach," SFB 649 Discussion Papers SFB649DP2015-035, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    9. Changqing Luo & Mengzhen Li & Zisheng Ouyang, 2016. "An Empirical Study on the Correlation Structure of Credit Spreads based on the Dynamic and Pair Copula Functions," China Finance Review International, Emerald Group Publishing, vol. 6(3), pages 284-303, August.
    10. Gehde-Trapp, Monika & Gündüz, Yalin & Nasev, Julia, 2015. "The liquidity premium in CDS transaction prices: Do frictions matter?," Journal of Banking & Finance, Elsevier, vol. 61(C), pages 184-205.
    11. Samaniego-Medina, Reyes & Trujillo-Ponce, Antonio & Parrado-Martínez, Purificación & di Pietro, Filippo, 2016. "Determinants of bank CDS spreads in Europe," Journal of Economics and Business, Elsevier, vol. 86(C), pages 1-15.
    12. Hertrich, Markus, 2015. "Does Credit Risk Impact Liquidity Risk? Evidence from Credit Default Swap Markets," MPRA Paper 67837, University Library of Munich, Germany.
    13. Rubia, Antonio & Sanchis-Marco, Lidia & Serrano, Pedro, 2016. "Market frictions and the pricing of sovereign credit default swaps," Journal of International Money and Finance, Elsevier, vol. 60(C), pages 223-252.
    14. repec:eee:intfin:v:51:y:2017:i:c:p:39-57 is not listed on IDEAS

    More about this item

    Keywords

    CDS; Liquidity; Credit risk; Financial crisis; Informed trading; Trade impact;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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