Limited Arbitrage and Liquidity in the Market for Credit Risk
Recent research has shown that default risk accounts for only a part of the total yield spread on risky corporate bonds relative to their risk-less benchmarks. One candidate for the unexplained portion of the spread is a premium for liquidity. We investigate this possibility by relating the liquidity of corporate bonds to the basis between the credit default swap (CDS) price of the issuer and the parequivalent corporate bond yield spread. The liquidity of a bond is measured using a recently developed measure called latent liquidity, which is defined as the weighted average turnover of funds holding the bond, where the weights are their fractional holdings of the bond. We find that bonds with higher latent liquidity are more expensive relative to their CDS contracts, after controlling for other realized measures of liquidity. However highly illiquid bonds with high default risk are also expensive, consistent with limits to arbitrage between CDS and bond markets, due to the higher costs of quot;shortingquot; illiquid bonds. Additionally, we document the positive effects of liquidity in the CDS market on the CDS-bond basis. We also find that several firm-level variables related to credit risk affect the basis, indicating that the CDS price does not fully capture the credit risk of the bond
Year of publication: |
[2009]
|
---|---|
Authors: | Subrahmanyam, Marti G. |
Other Persons: | Nashikkar, Amrut J. (contributor) ; Mahanti, Sriketan (contributor) |
Publisher: |
[2009]: [S.l.] : SSRN |
Saved in:
freely available
Extent: | 1 Online-Ressource (49 p) |
---|---|
Series: | NYU Working Paper ; No. FIN-08-011 |
Type of publication: | Book / Working Paper |
Notes: | Nach Informationen von SSRN wurde die ursprüngliche Fassung des Dokuments February 2009 erstellt |
Source: | ECONIS - Online Catalogue of the ZBW |
Persistent link: https://www.econbiz.de/10012764592
Saved in favorites
Similar items by person
-
Latent Liquidity : A New Measure of Liquidity, with an Application to Corporate Bonds
Mahanti, Sriketan, (2009)
-
Latent Liquidity : A New Measure of Liquidity, with an Application Corporate Bonds
Mahanti, Sriketan, (2009)
-
Price Dispersion in OTC Markets : A New Measure of Liquidity
Jankowitsch, Rainer, (2008)
- More ...