The Determinants of CDS Bid-Ask Spreads

Abstract

Recently, the issue of liquidity has generated considerable attention in financial research. In this article, Meng and ap Gwilym analyze the determinants of liquidity in the market for credit default swaps, as measured by the width of their bid-ask spreads. Many of the “usual suspects” are found to have explanatory power: Spreads were wider for higher CDS spread volatility, for lower issuer credit rating, and for sovereign vs. corporate issuers in speculative grades; spreads were lower for 5-year contracts than for nonstandard maturities, for larger transaction size, and for the years 2004 and 2005. One significant finding in the article is that a demand/supply imbalance between protection buyers and protection sellers significantly widens spreads.

TOPICS: Credit default swaps, fundamental equity analysis, real estate