The Transaction Costs of Trading Corporate Credit

Abstract

To examine whether corporate credit risk is cheaper to trade in the bond or credit-default swap (CDS) market, we estimate individual roundtrip transaction costs for 851 CDSs traded during 2009-2014. Effective half-spreads are 14 bps of the notional amount for dealer-to-enduser and 12 bps for dealer-to-dealer trades for the most common notional traded, $2.5-7.5M. Cross-sectionally, effective spreads are weakly correlated with indicative quoted spreads, higher for more actively traded contracts, and related to reference obligation/entity characteristics. For institutional-size trades up to $500K, bonds are three times as expensive as the corresponding CDSs, but at larger trade sizes this pattern reverses.

Keywords: Credit Risk, Credit Default Swaps, Bonds, Liquidity, Transaction Costs

JEL Classification: G11, G12, G14