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The reward for trading illiquid maturities in credit default swap markets

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  • Arakelyan, Armen
  • Rubio, Gonzalo
  • Serrano, Pedro

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.

Suggested Citation

  • Arakelyan, Armen & Rubio, Gonzalo & Serrano, Pedro, 2015. "The reward for trading illiquid maturities in credit default swap markets," International Review of Economics & Finance, Elsevier, vol. 39(C), pages 376-389.
    • Handle: RePEc:eee:reveco:v:39:y:2015:i:c:p:376-389
    DOI: 10.1016/j.iref.2015.07.006
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    Cited by:

    1. Chung, Kee H. & Park, Seongkyu “Gilbert” & Ryu, Doojin, 2016. "Trade duration, informed trading, and option moneyness," International Review of Economics & Finance, Elsevier, vol. 44(C), pages 395-411.
    2. Matthias Pelster & Johannes Vilsmeier, 2018. "The determinants of CDS spreads: evidence from the model space," Review of Derivatives Research, Springer, vol. 21(1), pages 63-118, April.
    3. Pelster, Matthias & Vilsmeier, Johannes, 2016. "The determinants of CDS spreads: Evidence from the model space," Discussion Papers 43/2016, Deutsche Bundesbank.

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    More about this item

    Keywords

    Credit default swaps; Illiquidity term structure; Intensity models; Default risk premium; Illiquidity risk premium;
    All these keywords.

    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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