Essays on CDS liquidity

The 2008 financial crisis is characterized by simultaneously drying up of liquidity across financial markets. It is critical to understand how liquidity was determined during the crisis. This dissertation focuses on liquidity properties in the Credit Default Swap (CDS) market mainly for two reasons. First CDS has been criticized for intensifying the systemic risk during the crisis. The size of the CDS market is so large that any large change in the CDS market could impose systemic risk to the entire financial system. Second CDS liquidity is less well studied in the literature. The first part of this dissertation investigates the implications of funding liquidity on liquidity, CDS-bond basis and volatility in the CDS market using a natural experiment comprised of a trading convention change in the CDS Big Bang (the protocol changes for the CDS market in April 2009). The findings provide direct evidence that a higher funding requirement reduces market liquidity, increases the absolute value of the CDS-bond basis, and CDS spread volatility and highlight an unintended consequence of the ongoing standardization of OTC markets—while its intention is to reduce systemic risk, standardization may significantly jeopardize market liquidity precisely during periods of financial distress. The second part of this dissertation examines the cross-market dynamics in marketwide illiquidity of the stock, bond and CDS markets for a long period of time spanning the 2008 financial crisis using a VAR framework. The correlations between the marketwide illiquidity measures of the three markets have been increasing since the onset of the 2008 financial crisis. Furthermore, the CDS market liquidity Granger causes the stock and bond market liquidity after the crisis. These findings suggest that financial regulations and changes in market infrastructure have significant effects on market liquidity.Ph.D.Includes bibliographical referencesby Xinjie Wan