Credit risk and liquidity in bond and CDS markets

The contribution of this thesis is to study the impact of different risk factors on bond prices and credit default swap (CDS) premia to explore the extent to which the different factors or sensitivities cause diverging price behavior. In particular, I focus on contractual differences between bonds and CDS and on the instrument-specific liquidity as two potential reasons for divergence, and I separate bond yield spreads and CDS premia into a credit risk, liquidity, correlation, and delivery option component. My main result is that CDS markets are systematically affected by liquidity premium surcharges for protection buyers. The reason is a prevailing demand pressure which increases CDS ask premia more strongly than bid premia. Bond and CDS liquidity premia exhibit a mostly positive dependence on credit risk premia, but the precise behavior depends on the rating class. The cross-market relation of the liquidity premia can be consistently interpreted by demand relations between the bond and the CDS market, and my results are robust against the inclusion of the delivery option in CDS contracts