Brown Bag Seminar with Anders Trolle, EPFL
FRIC is happy to announce the upcoming Brown Bag Seminar with Anders Trolle, Ecole Polytechnique Fédérale de Lausanne.
Anders Trolle will be presenting:
Liquidity risk in credit default swap markets
We analyze whether liquidity risk, in addition to expected illiquidity, affects expected returns on credit default swaps (CDSs). First, we construct a measure of CDS market illiquidity from divergences between published credit index levels and their theoretical counterparts, the so called index-to-theoretical bases. Non-zero and time-varying bases are observed across credit indices referencing North American and European names of both the investment grade and high-yield universes, and the aggregate measure can be viewed as a summary statistic of the impact of all the different dimensions of illiquidity that are present in the CDS market. Consistent with this, the measure correlates with transaction costs, funding costs, and other commonly used illiquidity proxies. Then, we construct a tradable liquidity factor highly correlated with innovations to the CDS market illiquidity measure and estimate a factor pricing model, which accounts for market risk and default risk in addition to liquidity risk and expected illiquidity. Liquidity risk is priced in the cross-section of single-name CDS returns and has a larger contribution to expected returns than expected illiquidity.
See the paper her: Liquidity risk in credit default swap markets