Liquidity Tail Risk and Credit Default Swap Spreads

European Journal of Operational Research, Forthcoming

46 Pages Posted: 25 Jan 2016 Last revised: 16 Feb 2018

See all articles by Felix Irresberger

Felix Irresberger

Durham University

Gregor N. F. Weiss

University of Leipzig - Faculty of Economics and Management Science

Janet Gabrysch

Technical University of Dortmund

Sandra Gabrysch

Technical University of Dortmund

Date Written: February 14, 2018

Abstract

We show that liquidity tail risk in credit default swap (CDS) spreads is time-varying and explains variation in CDS spreads. We capture the liquidity tail risk of a CDS contract written on a firm by estimating the tail dependence, i.e., the asymptotic probability of a joint surge in the bid-ask spread of the firm's CDS and the illiquidity of a CDS market index. Our results show that protection sellers earn a statistically and economically significant premium for bearing the risk of joint extreme downwards movements in the liquidity of individual CDS contracts and the CDS market. This effect holds in various robustness checks such as instrumental variable regressions and alternative liquidity measures and is particularly pronounced during the financial crisis.

Keywords: Credit default swaps, liquidity risk, copula, liquidity tail beta

JEL Classification: G12, G22, C58, G01

Suggested Citation

Irresberger, Felix and Weiss, Gregor N. F. and Gabrysch, Janet and Gabrysch, Sandra, Liquidity Tail Risk and Credit Default Swap Spreads (February 14, 2018). European Journal of Operational Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2720598 or http://dx.doi.org/10.2139/ssrn.2720598

Felix Irresberger

Durham University ( email )

Old Elvet
Mill Hill Lane
Durham, Durham DH1 3HP
United Kingdom

Gregor N. F. Weiss (Contact Author)

University of Leipzig - Faculty of Economics and Management Science ( email )

Grimmaische Str. 12
Leipzig, 04109
Germany
+49 341 97 33821 (Phone)
+49 341 97 33829 (Fax)

HOME PAGE: http://www.wifa.uni-leipzig.de/nfdl

Janet Gabrysch

Technical University of Dortmund ( email )

Emil-Figge-Straße 50
Dortmund, 44227
Germany

Sandra Gabrysch

Technical University of Dortmund ( email )

Emil-Figge-Straße 50
Dortmund, 44227
Germany

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