Implied liquidity risk premium in the term structure of sovereign credit default swap and bond spreads

In this study, we focus on the dynamic properties of the risk-neutral liquidity risk premium specific to the sovereign credit default swap (CDS) and bond markets. We show that liquidity risk has a non-trivial role and participates directly to the variation over time of the term structure of sovereig...

Full description

Saved in:
Bibliographic Details
Published inThe European journal of finance Vol. 22; no. 10; pp. 825 - 853
Main Authors Badaoui, Saad, Cathcart, Lara, El-Jahel, Lina
Format Journal Article
LanguageEnglish
Published London Routledge 08.08.2016
Taylor & Francis LLC
Subjects
Bond issues
Bond markets
Credit default swaps
International finance
Kalman filter
maximum likelihood
Risk premiums
riskneutral measure and liquidity risk
term structure of sovereign credit default swaps
Online AccessGet full text

Cover

More Information
Summary:In this study, we focus on the dynamic properties of the risk-neutral liquidity risk premium specific to the sovereign credit default swap (CDS) and bond markets. We show that liquidity risk has a non-trivial role and participates directly to the variation over time of the term structure of sovereign CDS and bond spreads for both the pre- and crisis periods. Secondly, our results indicate that the time-varying bond and CDS liquidity risk premium move in opposite directions which imply that when bond liquidity risk is high, CDS liquidity risk is low (and vice versa), which may in turn be consistent with the substitution effect between CDS and bond markets. Finally, our Granger causality analysis reveals that, although the magnitude of bond and CDS liquidity risk is substantially different, there is a strong liquidity flow between the CDS and the bond markets, however, no market seems to consistently lead the other.
ISSN:1351-847X
1466-4364
DOI:10.1080/1351847X.2014.996297