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The Journal of Fixed Income

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Are Liquidity and Counterparty Risk Priced in the Credit Default Swap Market?

Xiaoling Pu, Junbo Wang and Chunchi Wu
The Journal of Fixed Income Spring 2011, 20 (4) 59-79; DOI: https://doi.org/10.3905/jfi.2011.20.4.059
Xiaoling Pu
is an assistant professor of finance at Kent State University in Kent, OH.
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  • For correspondence: xpu2@kent.edu
Junbo Wang
is an associate professor of finance at City University of Hong Kong in Hong Kong.
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  • For correspondence: jwang2@cityu.edu.hk
Chunchi Wu
is a manufacturers and traders (M&T) Chair in Banking and Finance at State University of New York, in Buffalo, NY.
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  • For correspondence: chunchiw@buffalo.edu
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Abstract

This article examines the effects of liquidity and counterparty risk factors on CDS pricing. Using a marketwide counterparty risk measure, the authors estimate the risk premium associated with systematic counterparty defaults. They find evidence that both liquidity and counterparty risk factors are important over and beyond the effects of traditional default variables implied by the structural model. The effects of these factors are economically significant and stronger for reference entities with lower ratings. Systematic counterparty risk exerts a positive effect on the CDS spread. The relationships between CDS spreads and liquidity and default and marketwide counterparty risk factors vary in the face of changes in the market liquidity condition. Default and counterparty risk become greater concerns for investors during times of low liquidity in the financial market.

TOPICS: Credit default swaps, counterparty risk, information providers/credit ratings, statistical methods

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The Journal of Fixed Income: 20 (4)
The Journal of Fixed Income
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Spring 2011
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Are Liquidity and Counterparty Risk Priced in the Credit Default Swap Market?
Xiaoling Pu, Junbo Wang, Chunchi Wu
The Journal of Fixed Income Mar 2011, 20 (4) 59-79; DOI: 10.3905/jfi.2011.20.4.059

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Are Liquidity and Counterparty Risk Priced in the Credit Default Swap Market?
Xiaoling Pu, Junbo Wang, Chunchi Wu
The Journal of Fixed Income Mar 2011, 20 (4) 59-79; DOI: 10.3905/jfi.2011.20.4.059
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  • Article
    • Abstract
    • THEORETICAL DETERMINANTS OF CREDIT DEFAULT SWAP SPREADS
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    • EMPIRICAL RESULTS
    • CONCLUDING REMARKS
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