Economics, Econometrics and Finance
4 years ago

Sovereign bond and CDS markets linked by opposite liquidity risks.

SSRN Electronic Journal
Implied Liquidity Risk Premium in the Term Structure of Sovereign Credit Default Swap and Bond Spreads
Saad Badaoui, Lara Cathcart, Lina El-Jahel

Paper Summary

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The study explores how liquidity risk affects sovereign credit default swap (CDS) and bond markets. It finds that liquidity risk plays a significant role in shaping the term structure of CDS and bond spreads over time. The research shows that bond and CDS liquidity risk premiums move in opposite directions, suggesting a substitution effect between the two markets. Additionally, the analysis reveals a strong liquidity flow between CDS and bond markets, with no clear leader between the two.