ریسک نقدینگی و گسترش مبادله اعتباری Liquidity Tail Risk and Credit Default Swap Spreads

1 Introduction Over the past decades, the emergence and growth of credit derivatives markets have provided market participants with additional ways to invest in credit risk. Especially insurers, mutual funds, and pension funds entered these markets as net protection sellers as credit derivatives provided them with previously unattainable risk-return profiles. During the financial crisis, however, investments in credit derivatives markets exposed several insurers to extreme tail risk when both prices and illiquidity in the market for credit default swaps (CDS) as the most widely used credit derivative surged during the height of the crisis. In the case of the most prominent example of such an insurer, American International Group (AIG) faced bankruptcy and had to be bailed out as the U.S. government deemed AIG to be systemically important due to its involvement in the CDS market. Consequently, economists and regulators alike have taken a strong interest in investigating the role crash and liquidity risk play for investors in the CDS market. In this study, we try to answer the question whether liquidity tail risk is a significant driver of CDS spreads. We define a firm’s CDS contract’s liquidity tail risk as the propensity of the contract to experience a joint crash in its liquidity together with the liquidity of the CDS market. To measure this propensity, we propose the use of a dynamic copula model to estimate the asymptotic probability of both spread series jointly being in their extreme upper tail (i.e., their upper tail dependence). As a first result, we find average liquidity tail risk to be of small magnitude (about 0.2%) before the financial crisis. During the crisis, however, average liquidity tail risk almost doubled after the bailout of AIG and tripled at the start of 2009. We then estimate panel regressions of monthly CDS spreads on several proxies of liquidity tail risk in the CDS market and various controls. Our results confirm that the risk of a joint liquidity crash in the CDS market is significantly related to CDS spreads with sellers of credit protection demanding a premium for bearing liquidity tail risk.