Standardization, Transparency Initiatives and Liquidity in the CDS Market

Abstract

We investigate liquidity changes in the credit default swap (CDS) market around two events that increased market transparency and standardization during the Great Financial Crisis: the dissemination of CDS positions starting in November 2008, and the implementation of the Small Bang in July 2009. We build an econometric model based on bid and ask quotes to measure liquidity in thinly traded CDSs. We find that, after the release of CDS positions, the market-wide deterioration in liquidity is less important for banks, consistent with information revelation alleviating systemic risk uncertainty. The Small Bang also improved liquidity, particularly for more illiquid CDSs.

Keywords: Credit Default Swap, Liquidity, Transparency, CDS Volatility, Counterparty Risk

JEL Classification: C51, G14, G18