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Corporate Credit Default Swap Liquidity and Its Implications
for Corporate Bond Spreads

Ren-Raw Chen, Frank J. Fabozzi and Ronald Sverdlove
The Journal of Fixed Income Fall 2010, 20 (2) 31-57; DOI: https://doi.org/10.3905/jfi.2010.20.2.031
Ren-Raw Chen
the Graduate School of Business at Fordham University in New York, NY.
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  • For correspondence: rchen@fordham.edu
Frank J. Fabozzi
is a professor in the Practice of Finance at the Yale School of Management in New Haven, CT.
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  • For correspondence: frank.fabozzi@yale.edu
Ronald Sverdlove
is an assistant professor of finance at the School of Management at the New Jersey Institute of Technology in Newark, NJ.
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  • For correspondence: ronald.sverdlove@njit.edu
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Abstract

In a credit default swap (CDS) trade, a credit protection buyer acquires credit protection from the counterparty by paying a premium. The CDS premium has been viewed as a clean representation of the price of credit risk. As a result, in the past few years, researchers have used data on CDS trades where the reference entity is a corporation to determine the liquidity component of corporate bond spreads. Using a transaction dataset, the authors discover very large bid–ask spreads in CDS quotes. With a two-factor model, they show that such large bid–ask spreads can profoundly affect the estimation of credit risk, which in turn has a significant effect on the estimation of the liquidity spread for corporate bonds. Contrary to the literature, the authors show that although the bond and CDS markets appear to have two different values for the credit spread, once liquidity is accounted for they no longer find such a difference.

TOPICS: Credit default swaps, fixed-income portfolio management, factor-based models, simulations

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The Journal of Fixed Income: 20 (2)
The Journal of Fixed Income
Vol. 20, Issue 2
Fall 2010
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Corporate Credit Default Swap Liquidity and Its Implications
for Corporate Bond Spreads
Ren-Raw Chen, Frank J. Fabozzi, Ronald Sverdlove
The Journal of Fixed Income Sep 2010, 20 (2) 31-57; DOI: 10.3905/jfi.2010.20.2.031

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Corporate Credit Default Swap Liquidity and Its Implications
for Corporate Bond Spreads
Ren-Raw Chen, Frank J. Fabozzi, Ronald Sverdlove
The Journal of Fixed Income Sep 2010, 20 (2) 31-57; DOI: 10.3905/jfi.2010.20.2.031
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  • Article
    • Abstract
    • RELATED LITERATURE
    • DATA
    • SOME PRELIMINARY RESULTS
    • AN ESTIMATION OF LIQUIDITY
    • THE EFFECT OF CDS LIQUIDITY ON CORPORATE BOND SPREADS
    • CONCLUSIONS
    • APPENDIX
    • ENDNOTES
    • REFERENCES
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  • PDF (Subscribers Only)

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