Liquidity Tail Risk and Credit Default Swap Spreads

Irresberger, Felix; Weiß, Gregor N.F.; Gabrysch, Janet; Gabrysch, Sandra

Abstract

We show that liquidity tail risk in credit default swap (CDS) spreads is time-varying and explains variation in CDS spreads. We capture the liquidity tail risk of a CDS contract written on a firm by estimating the tail dependence, i.e., the asymptotic probability of a joint surge in the bid-ask spread of the firm’s CDS and the illiquidity of a CDS market index. Our results show that protection sellers earn a statistically and economically significant premium for bearing the risk of joint extreme downwards movements in the liquidity of individual CDS contracts and the CDS market. This effect holds in various robustness checks such as instrumental variable regressions and alternative liquidity measures and is particularly pronounced during the financial crisis.

Citation

Irresberger, F., Weiß, G. N., Gabrysch, J., & Gabrysch, S. (2018). Liquidity Tail Risk and Credit Default Swap Spreads. European Journal of Operational Research, 269(3), 1137-1153. https://doi.org/10.1016/j.ejor.2018.02.030

• Journal Article Type: Article
• Acceptance Date: Feb 13, 2018
• Online Publication Date: Feb 19, 2018
• Publication Date: 2018-09
• Deposit Date: Jul 23, 2020
• Publicly Available Date: Jul 24, 2020
• Journal: European Journal of Operational Research
• Print ISSN: 0377-2217
• Electronic ISSN: 1872-6860
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 269
• Issue: 3
• Pages: 1137-1153
• DOI: https://doi.org/10.1016/j.ejor.2018.02.030
• Public URL: https://durham-repository.worktribe.com/output/1265649
• Related Public URLs: http://eprints.whiterose.ac.uk/127526/