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Extracting Liquidity Risk Factors by Credit Default Swap Quotation and Corporate Bond Yield:
An Experimental Investigation

Extracting Liquidity Risk Factors by Credit Default Swap
Quotation and Corporate Bond Yield: An Experimental
Investigation

Chung-Ying Yeh, Department of Finance, National Chung-Hsing University
Ren-Raw Chen, Graduate School of Business Administration, Fordham University, U.S.A.
Bing-Huei Lin, Department of Finance, National Chung-Hsing University
Shih-Kuo Yeh, Department of Finance, National Chung-Hsing University

1. Purpose

As widely known that corporate bonds are illiquid, yields of corporate bonds
therefore contain significant premiums to compensate for insufficient liquidity. On the
other hand, Credit Default Swap (CDS) products, ever since its introduction to the market
in the mid 1990s, have been more actively traded. As a result, it is an interesting question

whether or not their quotes include liquidity risk premium. Many scholars consider CDS
spreads as a measure of pure credit risk, yet still others believe that the spreads affect
prices and hence must be associated with liquidity or other risk factors.
This study tries to use a comprehensive GFI CDS dataset to estimate the liquidity

premiums in bond yields and CDS quotes simultaneously using consistent econometrics
methods. In particular, we measure the liquidity premium embedded in the bond yields to
examine how CDS liquidity affects the yield spread of the corresponding bonds. Thus, we
can provide the link between the liquidity premiums in both the CDS and the corporate

bond markets.

2. Approach

This paper employs two kinds of data. The first is CDS market quotations in the
United States. Collected from the GFI CDS dataset, it covers all transactions of the period
from July 2001 to October 2015. This dataset contains over ten million observations
(4,135,728 bids, 3,762,940 asks, and 3,252,511 trades) across 2,677 reference entities.

The other data is the corporate bond yield data collected from Trade Reporting and
Compliance Engine (TRACE) matched with CDS market quotations. Moreover, we collect

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