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Endogenous liquidity in credit derivatives

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  • Qiu, Jiaping
  • Yu, Fan

Abstract

We study the determination of liquidity provision in the single-name credit default swap (CDS) market as measured by the number of distinct dealers providing quotes. We find that liquidity is concentrated among large obligors and those near the investment-grade/speculative-grade cutoff. Consistent with endogenous liquidity provision by informed financial institutions, more liquidity is associated with obligors for which there is a greater information flow from the CDS market to the stock market ahead of major credit events. Furthermore, the level of information heterogeneity plays an important role in how liquidity provision responds to transaction demand and how liquidity is priced into the CDS premium.

Suggested Citation

  • Qiu, Jiaping & Yu, Fan, 2012. "Endogenous liquidity in credit derivatives," Journal of Financial Economics, Elsevier, vol. 103(3), pages 611-631.
    • Handle: RePEc:eee:jfinec:v:103:y:2012:i:3:p:611-631
    DOI: 10.1016/j.jfineco.2011.10.010
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    More about this item

    Keywords

    Credit derivatives; Dealers; Liquidity provision; Informed trading;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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