Anatomy of Trading and Liquidity in the Credit Default Swaps Market

Abstract

Trading in the multi-trillion dollar credit default swaps (CDS) market has remained a mystery to most due to lack of available data. We propose to demystify this market by employing a unique data set of all trades with anonymized counterparty information at daily level from January 2007 to date of North American single-name CDS. In particular, we seek to explain for the CDS market the extent and nature of trading (by whom – dealer or buy-side players and how concentrated) and its liquidity measured in different ways using number of trades, volume, price dispersion and price impact. Our primary economic inquiry is to document and understand the time-series variation in CDS market liquidity, especially the change from prior to the crisis (pre-August 2007) to during the crisis, with a focus on significant events of stress to the CDS markets such as 9th August 2007 (money market 'freeze'), 14th March 2008 (the collapse of Bear Stearns) and 15th September 2008 (Lehman Brothers’ failure), and employing equity and bond market liquidity changes as controls for trading stress unrelated to the CDS markets.