CDS Market Liquidity How Liquid is the CDS Market by Adreas Fulop and Laurence Lescourret CDS Liquidity by Ren-Raw Cehn, Franck Fabozzi and Ronald Sverdlove

Objectives CDS premiums contain credit risk AND liquidity problems => CDS premiums cannot be used as pure credit risk measures Analysis of CDS market liquidity for a better understanding of volatility and transaction costs on CDS market (FL2007) or for a better understanding of bond spreads (CFS2007) Hot topic these days Can we get some insight concerning recent credit event ?

Objectives CDS premiums contain credit risk AND liquidity problems => CDS premiums cannot be used as pure credit risk measures Analysis of CDS market liquidity for a better understanding of volatility and transaction costs on CDS market (FL2007) or for a better understanding of bond spreads (CFS2007) Hot topic these days Can we get some insight concerning recent credit event ?

Objectives CDS premiums contain credit risk AND liquidity problems => CDS premiums cannot be used as pure credit risk measures Analysis of CDS market liquidity for a better understanding of volatility and transaction costs on CDS market (FL2007) or for a better understanding of bond spreads (CFS2007) Hot topic these days Can we get some insight concerning recent credit event ?

Société Générale and BNP- Paribas

Bear Stearns

Models FL (2007) Microstructure model of efficient price and quotes Hasbrouck (2003) Analysis of intraday volatility and transaction cost Mostly descriptive CFS (2007) Reduced-form model of credit risk with liquidity factors for the bonds and CDS markets Bulher and Trapp (2006)

Data FL (2007) Intraday CDS bid and ask quotes + trades from GFI stamped down to a minute 3 US + 1 European entities January 2004 – December 2006 Each day = 5 time periods 5:30-7:30, 7:30-9:30, 9:30- 14:30, 14:30-16:30 and 16:30-5:30 NY GMT CFS (2007) Intraday CDS bid and ask quotes + trades from Creditex February 2000 – April information about the companies from FISD data set + bond information from TRACE data set reduced to one observation per day

Data problems FL (2007) Sample : take the last bid and ask (every minute) Remove the joint observation with negative or null bid-ask spread CFS (2007) Remove the repeating entries and bad data points Interpolate bid and ask to end up with joint bid and ask observations Remove the observation with negative or null bid- ask spread

Data problems FL (2007) Sample : take the last bid and ask (every minute) Remove the joint observation with negative or null bid-ask spread CFS (2007) Remove the repeating entries and bad data points Interpolate bid and ask to end up with joint bid and ask observations Remove the observation with negative or null bid- ask spread Is there such corrections ?

Data problems FL (2007) Sample : take the last bid and ask (every minute) Remove the joint observation with negative or null bid-ask spread CFS (2007) Remove the repeating entries and bad data points Interpolate bid and ask to end up with joint bid and ask observations Remove the observation with negative or null bid- ask spread

Data problems FL (2007) Sample : take the last bid and ask (every minute) Remove the joint observation with negative or null bid-ask spread CFS (2007) Remove the repeating entries and bad data points Interpolate bid and ask to end up with joint bid and ask observations Remove the observation with negative or null bid- ask spread How often that happens ?

Model and Estimation FL (2007) Hasbrouck (2003) model for efficient price m t =m t-1 + q t-j j +u t Here efficient log spread m i =m i -1 + m i - i m i -1 + f( i -1, i ) (u i +N i Z i ) Then A=M+C, where C is the cost of market making Filtering + MC EM algorithm to account for time varying volatility, jumps and data errors

Model and Estimation CFS (2007) Estimation of hazard rate and liquidity factor based on mid-CDS quotes and ask CDS quotes. Fixed rate corporate bond pricing formula with or without liquidity impact => yield to maturity Estimation of a one-factor model for liquidity

Results FL (2007) Lost in the tables and graphs, missing explanations and interpretations (ex: J-shaped pattern for volatility parameter table 3, no comment fig 1-14, no title fig 7- 10) CFS (2007) Counterintuitive results: Fig. 11 as mentioned by the authors. The relations described do not show (ex: increasing a with rating Fig 12), we do not have standard deviations.

FL (2007)

J-Shaped pattern

FL (2007) J-Shaped pattern Picks up during off hours

CFS (2007)

Increasing in rating for the industrial sector

CFS (2007) Increasing in rating for the industrial sector Increasing in rating decreasing in rating for CORP, flat for FI

CFS (2007) Hazard Liquidity No relation The larger the firm the more liquid the premium

Results FL (2007) Bid ask spreads and roundtrip cost are not lower than their counterparts in the corporate bond markets Framework allows for data errors, price discreteness and jumps Volatility is low and transaction costs are higher when trading is thinner. CFS (2007) Large bid-ask spreads in CDS quotes can affect the estimation of the liqui- dity spreads of bonds Liquidity risk is idiosyncratic Liquidity is positively related to credit risk Liquidity premium is uncorrelated to credit risk

Comments Very interesting and still a lot to do to understand CDS markets. Data are a real problems. Not sure long sample can be used.

Comments FL (2007) Microstructure model + filtering and MC EM estimation is interesting. Stable period. Can serve as a benchmark to analyze the recent evolution. CFS (2007) Data treatment in not neutral. Since liquidity is increasing, could be more interesting to do the same analysis in 2003, 2004, …,2007

SEARS

Last comments Normal liquidity ? Cross effects ? Link with daily liquidity ?

Daily Data