Cross-market liquidity shocks: Evidence from the CDS, corporate bond and equity market. Working Paper

Using data from the credit default swap (CDS), corporate bond, and equity markets, we construct several measures of liquidity and examine the spill-over of liquidity shocks across these markets. Based on the principal component analysis of multiple liquidity measures, we show that there is a dominant first principal component in each of the markets. However, the linkage of liquidity shocks varies between different markets. In particular, there is a common component between the equity and both CDS and bond markets, but not between the CDS and bond market. Moreover, the vector autoregression results show that while there is spill-over of liquidity shocks between equity and CDS markets, surprisingly there is no clear spill-over of liquidity shocks between equity and bond markets. There appears to be a time lag of liquidity spill-over from the CDS to both bond and equity markets. Finally, we find no evidence of liquidity spill-over from bond to CDS market. Key Words: Liquidity shock; Commonality