How liquid is the CDS market

A common belief is to qualify the credit default swap(CDS) market as very liquid. However, looking at intra-daily CDS data on individual firms from a major inter-dealer broker, we find only limited support for this view. In fact, bid-ask spreads and daily number of trades in our CDS data are more comparable to corporate bond markets than to equity markets. To dig deeper in our data set, we estimate a state-space model of CDS bid and ask quotes on our data. Our model allows for price discreteness, data-errors, heterogeneity of the quotes, jumps in the efficient spreads and intra-daily patterns both in the volatility of the efficient CDS premium and proportional transaction costs. We estimate the model using particle filtering and the Monte Carlo EM algorithm. The volatility of the efficient premium and transaction costs exhibit the usual J-shaped intra-daily pattern observed in equity markets. Also, volatility is much lower during overnight periods and transaction costs much higher