Abstract
This article explores the impact of liquidity on Credit Default Swap (CDS) spreads. We proxy for CDS liquidity using measures that capture several dimensions of liquidity. We characterize the relationship between liquidity and default swap spreads in two ways: first, we perform a panel data analysis to study the link between our liquidity proxies and CDS spreads. Our sample comprises a panel with more than 280 US firms. Second, we examine whether liquidity is priced by CDS investors by examining the interactions between our liquidity proxies and the risk premium embedded in CDS spreads. The default risk premium accounts for 40% of CDS spreads. Our results indicate that the bid-ask spread and noise measures are important factors in explaining the illiquidity of both CDS spreads and risk premia. The Fitch liquidity score and the number of contributors are poor measures of liquidity.
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